What is mortgage refinancing?
Mortgage refinancing in a layman language means that you are taking new mortgage loan to replace the existing one. Opportunity to refinance mortgage by homeowners is one of the advantages you can enjoy when you own your own house. Apart from the fact that the home serves as a place of abode for you, it is actually an investment. Besides, if you have a good equity in your home, it can also be a source of cheap loan to you. If you choose to refinance your mortgage, the new mortgage loan usually comes with new terms and condition and associated costs. It doesn’t matter whether you are getting the loan from new or existing lender. But raising fund is just one out of many reasons why a homeowner may choose to consider mortgage refinancing. Below are reasons why people may choose to refinance their mortgage loans.
Why Mortgage Refinancing?
- Lower Interest rate. Interest rate is a major factor to consider when taking any loan whether secured or unsecured. If the interest rate on a loan is too high, the interest payment may become a burden to the borrower. It may even lead to late or missed payments at times. High interest rate is a major reason some people have remained in debts perpetually. It is not that they are not making efforts to pay back their loans; the problem is that greater portion of the repayment they make may be going towards the payment of interest while the principal remains. This situation usually happens when a borrower only makes minimum payment at the end of each month. Although mortgage loans usually attract less interest rates when compared to other loans. This is because the home serves as security for the loan. Therefore, in case of default, the lenders have something to fall back on as security for their money. That is why mortgage is considered a low risk loan and this makes it attract less interest rates. Notwithstanding, individuals will still be assessed based on his credit worthiness to determine the interest rate that will be applicable to him.
If you have existing mortgage loan, you may want to seek for lesser interest rate. That is one of the reasons people choose to refinance their mortgage loan. If this is your objective for mortgage financing, I will encourage you have a set goal concerning the amount of savings you seek to achieve. What percentage of savings do you think will be enough justification for you to refinance your mortgage? Will 1% or 2% per cent savings be sufficient for you? This may depend on the amount of mortgage you owe. For instance, 2% of $150,000 mortgage loan is $3,000. This amount may be substantial saving enough to justify mortgage financing. But for a loan of $50,000, pursuing 1% savings on interest may not justify your efforts. Also, you should not be carried away by the interest rate only. It is important to mention here that you may not qualify for the interest rates the lenders usually advertise on their websites. In most cases, they will advertise the lowest rates in order to attract homeowners that want to refinance their mortgage loans. By the time they conduct a review of your credit, you may be charged a higher interest rate. So, if you base your calculation on the interest rates they advertise, your assumption may be totally wrong. Before you embark on mortgage refinancing, it is good that you discuss with two or three lenders first. This will give you a clue of the rates that will be applicable to you. And it will help you consider whether the mortgage refinancing will help you save interest or not. Under the new Home Affordable Refinance Program created by the federal government, eligible homeowner can now refinance their homes at affordable rates. The good news about Home Affordable Refinance Program is that you can still refinance your home even when it has declined in value or you little equity in your home. But before you can be considered for mortgage refinance under Home Affordable Refinance Program, you need to be able to demonstrate acceptable payment history on the existing mortgage loan.
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- Convert adjustable rate mortgage (ARM) fixed-rate mortgage: Basically, there are two types of mortgage loan namely adjustable rate mortgage (ARM) and fixed-rate mortgage. With adjustable rate mortgage (ARM), the rates may be low initially, say for the first five or seven years. Thereafter the rate will later increase. While the initial interest rates of adjustable rate mortgage (ARM) may be lower than that of fixed-rate mortgage, it will be increased to reflect the market rates index. However if the index goes down, the adjustable rate mortgage may also enjoy reduced interest rates. This option is actually good for people who are not planning to stay in their home longer than the initial loan term or they intend to sell the house very soon. If you are in this class, you can take advantage of the low interest rates at the initial years. But in case the market index rate increases, you will need to pay higher interest rates too, On the other hand, fixed-rate mortgage gives you a constant interest rate, That is, you pay a fix principal and interest amount over the life of the mortgage loan. This may span through 15, 20 or 30 years duration. With fixed-rate mortgage, you are able to plan your cash flow as the interest and principal repayment remain constant over the life of the mortgage. Another advantage of fixed-rate mortgage is that you are not concerned about whether the interest rates are rising or not. But in case there is general fall in interest rate, this becomes a disadvantage. Because of the fluctuation in interest rates, one may decide to refinance his mortgage loan. Mortgage refinancing in this context may mean changing from fixed-rate mortgage to adjustable rate mortgage or vice versa depending on the prevailing circumstance.
The question you may want to ask here is: “How do I know when to refinance mortgage loan or how do I know the mortgage loan option that is good for me?” If you have been on adjustable rate mortgage thinking that you will not stay long in the house but the situation has changed which may necessitate that you stay for a long period in the house, it may be a right time to think about mortgage refinancing. In this case, you may want to switch to fixed rate mortgage in order not to be caught up with the rise in interest rate after the initial low interest rate on your adjustable rate mortgage has expired. But if you are planning to sell the house within five and seven years period, you may want to take advantage of the initial low interest rates under adjustable rate mortgage. If there is general fall in interest rates, it may be the right time to refinance mortgage so that you can lock up the low interest rate with fixed rate mortgage.
Change of Mortgage Company: If you are not happy with the level of customer service you receive from your lender, mortgage refinancing can provide an avenue for you to change to another lender. It is not compulsory that you have to change your lender if you want to refinance mortgage loan. If you are comfortable with the service which your current lender provides, it may be a good idea to refinance with your existing lender. This may even save you some costs involved in mortgage refinance.
- Cash out Equity: It is possible that you have built high equity on your home overtime. You can use mortgage refinancing to cash out your equity. That is, you are refinancing for the amount that is more than you owe on your home. You can cash out the difference and use it to finance large purchase such as acquisition of new car, home improvement or payment of debts with very high interest rates. Your home equity can increase because of the increase in your home value. But you need to remember that taking out of your equity has a way of lowering your home equity. It will take some time before you build your equity back. If you are refinancing in order to pay off debts, you need to ensure that you don’t accumulate another debt thereby negating the benefits of refinancing the mortgage. If you are cashing out your home equity in order to invest, it will not make sense if the returns you will get on the investment will be lower than the interest you will be paying on your mortgage loan. However, mortgage loan refinance could be a good of source of finance if you use the money on worthwhile endeavour such as paying for child’s education. This can be cheaper than taking student’s loan.
- Better term: Mortgage refinancing can help you lower your monthly payment as you extend the loan period. But if you have already paid substantial part of your existing mortgage, it may not be appropriate refinancing the mortgage again. In the early part of your mortgage, large proportion of the repayment you make goes to interest payment. As you are getting close to the end of the mortgage term, this trend will be changing gradually. Large part of the money you pay will now be going towards the payment of the principal. So, if you refinance mortgage when you are almost done with the payment of the loan, it is like going back to ground zero. Greater portion of any payment you make will be going to the repayment of the interest. But if still have up to twenty years left, mortgage refinancing can help you lower the amount you pay every month. For example, if you have twenty years left, you can refinance for thirty years at lower interest rate. But this may translate to increase in interest payment in the long run. It will be good if you can maintain the same monthly payment on your existing loan. This can help you accelerate the repayment of the loan and you will be able to build equity more quickly.
- Termination of Private Mortgage Insurance (PMI). If you are familiar with mortgage loan, you will know that lenders will usually require that you make at least 20% down payment. If you can’t provide this 20%, it may be difficult getting lenders who will be ready to finance your home. But things are changing gradually. Some companies allows low down payment on their mortgage loan but they will certainly require the homeowner to take insurance as a security against default. That means you may not necessarily have up to 20% down payment before you can access mortgage loan. Private Mortgage Insurance is to protect the lender in case of any default which may ultimately lead to foreclosure. That is, homeowners are not actually the beneficiary of this insurance but the lenders. Private Mortgage Insurance is an additional cost to homeowners and this is paid annually until they are able to build their total equity on the home to 20%. Mortgage insurance can be as high as 1.5% of the loan amount. The mortgage insurance rate is a function of many factors such as your credit score, the size of your down payment, loan type and the possibility for the property to increase or decline in value. Mortgage refinancing can be a way out of this situation especially when the value of your home has increased which may make you qualify for new mortgage loan without Private Mortgage Insurance.
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- Tax advantage: If you are taking additional loan via mortgage refinancing, the interest on the loan is tax deductible. This can help you reduce your tax liability especially if you are already in or about to enter large tax bracket. Whatever you can save here will surely improve your cash flow.
- Better credit score: If you finance your home with fixed rate mortgage, it is possible that you are already locked up in interest rate that is no longer favourable to you. If your credit score improves, you may be qualified for a lower interest rate. Even if your credit score has not improved significantly, you can start working on it. It may make sense to apply for your free credit report and review it for possible errors which may have negative effects on your credit. Any time you know that your credit score has improved considerably compared to what it was when you obtained your existing mortgage loan, you can apply for mortgage refinancing if you still have many years to end of the mortgage term.
- Unstable economy: Many things happen during recessionary period. During this period, a lot of homeowners find it difficult to pay their mortgage. Some may even experience loss of their source of income. Instead of losing their home to foreclosure, it makes sense to opt for mortgage refinancing. This can help them rearrange their payments in the manner that will be comfortable for them. On the other hand, if there is increase in income, one may like to invest in another property which he may want to refinance through mortgage. In order to meet up with 20% equity in the new property, the option may be to refinance current mortgage loan if he has already built enough equity in it.
- Loan consolidation. When you refinance your mortgage to pay off other debts, it is more likely that you will be paying off debts of shorter terms with a loan having longer repayment term. If you don’t do your calculation very well, you may end up paying more interest on the loan. Besides, you will be increasing your risk exposure by taking a secured loan to replace unsecured loans. You know the implication of this. If you default in payment, you stand the risk of losing your home. That is why you need to evaluate all possible options before concluding on mortgage loan refinancing.
Costs Involved in Mortgage Refinancing
Mortgage refinancing may seem very attractive until you sit down to analyse the costs you may likely incur and then compare it with savings you may likely make. It can cost within the range of 3% and 6% of your loan principal to refinance mortgage loan. When you hear about no-fee mortgage refinancing, that may not mean you will not incur any cost. Some lender may choose to pay certain fees by themselves while they pass the costs to their customers by way of higher interest rates. I am saying this so that you will know how to compare offers from different lenders especially if you are shopping for cheap mortgage rates. Below are some of the costs involved in mortgage refinancing.
- Application fee: If you want to refinance your mortgage loan, you need to apply afresh for new one the same way you did for the existing one. Even if you are applying to your existing lender, you still need to do this as you will be closing the current one in order to open a new one. The fee you pay for applying is called application fee. This amount is non-refundable as you still need to pay it even though your application is not approved.
- Appraisal fee: Mortgage refinancing requires that a new valuation of the property is conducted by the new lender. This is to determine whether your home still has enough value in relation to the mortgage loan you want to obtain. This will determine how much the lender will be willing to advance to you and the terms that will be suitable to you. If the valuation reveals that the value of your home has declined, you may be required to pay certain amount as down payment. Alternatively, you may be asked to buy mortgage insurance. Some lenders may include this fee in their application fee. That is why you need to ask questions so that you are aware of what fees you need to pay. This will help you while comparing mortgage refinancing deals. If you need a copy of the appraisal, you can ask your lender. Part of the appraisal may include making inquiry on your credit. Your credit score will contribute to the interest rate you will be offered.
- Originating fee: You can call this document preparation fee. It is the fee that your lender charges you for them to evaluate and prepare your mortgage loan. This is usually on an average of 1% of the total value of the loan.
- Discharge fee: Mortgage loan refinancing requires that you pay off the existing loan before you get the new one. Your new lender will charge you for the administration fee paid to your current lender to pay your current loan in full and for necessary documentation.
- Inspection fee: There may be a need to carry out physical inspection on your home in order to determine if any damage has been done to the property and extent of the damage. Damage can be caused by pests or termites. It might even be as a result of structural problems. If such inspection is carried out, you will need to pay inspection fee before your mortgage loan is finally released to you. Depending on where your property is located, you may need to pay for flood certification.
- Attorney review/closing fee: Your lender will need to engage a lawyer/attorney to conduct closing of the loan for them. This legal fee paid by the lender to the lawyer will be charged back to you. This fee is known as attorney review and closing fee.
- Title search and title insurance: If you apply for mortgage refinancing, the lender will like to conduct a search about the property involved in order to determine its rightful owner. Even if it is ascertained that you are the rightful owner, the lender will want to be sure that the property has not been used as collateral for any loan. Nevertheless, that is not to say that no errors will be made regarding the title search. If this happens, the insurance will provide a cover for the lender’s investment in the mortgage.
- Survey fee: You may be wondering why the lender still needs to carry out a fresh survey of the property. You should understand that certain type of property is expected to be located in a particular place based on the regional planning of the environment. Also, it may be that certain improvements have taken place where the property is located. However, if you have a survey of the property which is still recent, this can be waived for you.
- Early repayment penalty: If you want to take any loan, you need to read the terms and condition that apply to such loan in order not to be caught with surprise in the future. Some people don’t mind signing any document when they are in need of a loan. Such people may want to argue with their lender when it comes to the enforcement of the loan term which they had agreed to. One of such terms is the early repayment penalty. If the term of a loan include early repayment penalty, it means that you are not expected to pay off the loan before the loan term period even if you have the money to discharge the loan. If you insist on settling the loan before the maturity date, then you will be asked to pay a penalty. So, before you refinance your mortgage, you need to find out if early repayment penalty exists on your existing mortgage loan. If it exists, you need to add this to your costs and then compare to the savings you plan to make through the mortgage refinancing.
- Credit report fee: There is a possibility that your credit score must have changed between now and when you apply for the current mortgage. Your potential lender will conduct a review of your credit score. This is essentially to help them determine the interest rate that will be applicable to you based on your creditworthiness. Some lenders will include this as part of the appraisal fee.
- Mortgage insurance: If your equity is less than 20%, your lender will require you to buy mortgage insurance. Please note that you are not the beneficiary of this insurance. It is essentially to protect your lender against any default.
In conclusion, mortgage refinancing may be a good source of finance if used properly. However, you need to realise that cashing out of equity provide you with excess money. You need to be disciplined enough to be sure that you don’t spend the money on frivolous things. If you are using it to pay off debts, this may seem like a good idea but you need to be sure that you don’t slip back into accumulating another tons of debts. Also, when you cash out your equity to pay unsecured debts, you are actually exposing yourself as you stand the risk of losing your property in case of default. Furthermore, you need to understand that “no-fee” mortgage refinancing is a myth. You may not be paying the fee directly; you will be paying it in form of higher interest rate. The costs involved in mortgage refinancing can actually erode the savings you are trying to make. Therefore, you need to evaluate all your options before settling for mortgage refinance.