The refinancing process: When you refinance, you actually payoff your current mortgage and enter into a new mortgage agreement.
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Mortgage Refinancing Benefits:
Lower interest rate - the interest rate on your mortgage is tied directly to how much you pay on your mortgage each month. Hence, lower rates typically result in lower payments. You may be able to get a lower rate because of changes in the market conditions or because your credit score has improved, qualifying you for lower rates. A lower interest rate also may allow you to build equity in your home more quickly.
Example comparison - compare the monthly payments (for principal and interest) on a 30 year fixed rate loan of $200,000 at 5.5% and at 6.0%.
| Monthly mortgage payment @ 6.0%: | $1,199 |
| Monthly mortgage payment @ 5.5%: | $1,136 |
| The savings per month at 5.5%: | $63 |
| The savings per year at 5.5%: | $756 |
| The savings per decade at 5.5%: | $7,560 |
Lower payments with a longer term - by refinancing to a longer term, you can reduce the amount of your monthlypayment. Naturally this increase in the term length will make more mortgage payments and a larger total amount that you'll end up paying on interest.
Payoff sooner - by refinancing to a shorter term mortgage such as switching from a 30 year mortgage to a 15 year mortgage, you can not only payoffsooner but also save money with lower interest rates. Naturally, your monthly payments usually are higher because you are paying more of the principal each month.
Example comparison - compare the total interest costs for a fixed rate loan of $200,000 at 6% for 30 years with a fixed rate loan at 5.5% for 15 years.
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| Monthly payment | Total interest |
| 30 year loan @ 6.0% | $1,199 | $231,640 |
| 15 year loan @ 5.5% | $1,634 | $ 94,120 |
Tip: Refinancing is not the only wayto decrease the term of your mortgage. You can pay a little extra towards principal each month, and you will pay off the loan sooner and reduce the term.For example, adding $50 each month to your principal payment on the 30 year loanabove reduces the term by 3 years and saves you more than $27,000 in interestcosts.
Change from an adjustable rate mortgage to a fixed rate mortgage -If you have an adjustable rate mortgage, or ARM, your monthly payments willchange as the interest rate changes. With this kind of mortgage, your paymentscould increase or decrease.
If you want the security of having a constant mortgage payment without fear ofincreasing, you may want to consider switching to a fixed rate mortgage. You also might prefer afixed rate mortgageif you think interest rates will be increasing in the future.
Tip: If your monthly payment on a fixed rate loan includes escrow amounts for taxes and insurance, your paymenteach month could change over time due to changes in property taxes, insurance,or community association fees.
To get an ARM with better terms - If you currently have an ARM, will the next interest rate adjustment increaseyour monthly payments substantially? You may choose to refinance to get anotherARM with better terms. For example, the new loan may start out at a lowerinterest rate. Or the new loan may offer smaller interest rate adjustments orlower payment caps, which means that the interest rate cannot exceed a certainamount. For more details, see the ConsumerHandbook on Adjustable-Rate Mortgages.
Tip: If you are refinancing from oneARM to another, check the initial rate and the fully indexed rate. Also askabout the rate adjustments you might face over the term of the loan.
To get cash out from your home's equity - Home equity is thedollar value difference between the balance you owe onyour mortgage and your home's value. When you refinance for an amountgreater than what you owe on your home, you can receive the difference in a cashpayment (cash out refinancing). This is a good option for those who want toremodel, fund college, or perform some other investment.
Advice: Think twice before taking this option, as it will take time to rebuild your equity. This meansyou'll have less equity available if you need to sellyour home or have an emergency situation when you desperately need cash.
If you are considering a cash out refinancing, think about other alternatives aswell. You could shop for a home equity loan or home equity line of creditinstead. Compare a home equity loan with a cash out refinancing to see which isa better deal for you. See WhatYou Should Know about Home Equity Lines of Credit.
Advice:Many financial advisers warn against cash out refinancing to payoff debt.Consult with atrusted financial adviser before you choose cash out refinancing as a debtconsolidation loan.
MortgageRefinancing Cons:
Lost equity - The amortization chart shows that the proportion of your payment that iscredited to the principal of your loan increases each year, while the proportioncredited to the interest decreases each year. In the later years of yourmortgage, more of your payment applies to principal and helps build equity. Byrefinancing late in your mortgage, you will restart the amortization process,and most of your monthly payment will be credited to paying interest again andnot to building equity.
Amortization of a $200,000 loan for 30 years at 5.9%
Prepayment penalty - This applies only if your lender will chargeyou a prepayment penalty fee if you pay off yourmortgage loan early, including for refinancing. If you are refinancing with thesame lender, first ask whether the prepayment penalty can be waived. You shouldcarefully consider the costs of any prepayment penalty against the savings youexpect to gain from refinancing. Paying a prepayment penalty will increase thetime it will take to break even, when you account for the costs of the refinanceand the monthly savings you expect to gain.
Relocation - If you plan to move from your home in the next fewyears, the monthly savings gained from lower monthly payments may not exceed thecosts of refinancing.
Refinancing Requirements:
Qualification for refinancing is similar to the approval process you underwent with your first mortgage. Your lender willconsider your income and assets, credit score, other debts, the current value ofthe property and the amount you want to borrow. If your credit score hasimproved, you may be able to get a loan at a lower rate. On the other hand, ifyour credit score is lower now than when you got your current mortgage, you mayhave to pay a higher interest rate on a new loan.
Lenders will look at the amount of the loan you request and the value of yourhome, determined from an appraisal. If the loan-to-value (LTV) ratio does notfall within their lending guidelines, they may not be willing to make a loan, ormay offer you a loan with less-favorable terms than you already have.
If housing prices fall, your home may not be worth as much as you owe on themortgage. Even if home prices stay the same, if you have a loan that includesnegative amortization (when your monthly payment is less than the interest youowe, the unpaid interest is added to the amount you owe), you may owe more onyour mortgage than you originally borrowed. If this is the case, it could bedifficult for you to refinance.
Refinancing Cost: It is not unusual to pay 3 to 6% of your outstanding principalin refinancing fees. These expenses are in addition to any prepayment penaltiesor other costs for paying off any mortgages you might have.Refinancing fees vary from state to state and lender to lender. Here are sometypical fees and average cost ranges you are most likely to pay whenrefinancing.
Advice: You can ask for a copy of yoursettlement cost papers (the HUD-1 form) one day in advance of your loan closing.This will give you a chance to review the documents and verify the terms.
Application fee. This charge covers the initialcosts of processing your loan request and checking your credit report. If yourloan is denied, you still may have to pay this fee.Cost range is $75 to $300.
Loan origination fee. The fee charged by the lender orbroker to evaluate and prepare your mortgage loan. Cost rangeis 0% to 1.5% of the loan principal.
Points. A point is equal to 1 percent of the amount ofyour mortgage loan. There are two kinds of points you might pay. The first isloan-discount points, a one-time charge paid to reduce the interest rate of yourloan. Second, some lenders and brokers also charge points to earn money on theloan. The number of points you are charged can be negotiated with the lender.Cost range is 0% to 3% of the loan principal.
Advice: The length of time that youexpect to keep the mortgage helps you determine whether it is worthwhile to paypoints up front to reduce your interest rate. Unlike points paid on youroriginal mortgage, points paid to refinance may not be fully deductible on yourincome taxes in the year they are paid. Check with the InternalRevenue Service to find the current rules for deducting points.
Appraisal fee. This fee pays for an appraisal of yourhome, in order to assure the lenders that the property is worth at least as muchas the loan amount. Some lenders and brokers include the appraisal fee as partof the application fee. You are entitled to a copy of the appraisal, but youmust ask the lender for it. If you are refinancing and you have had a recentappraisal, you can check to see if the lender will waive the requirement for anew appraisal.Cost range is $300 to $700.
Inspection fee. The lender may require a termiteinspection and an analysis of the structural condition of the property by aproperty inspector, engineer, or consultant. Lenders may require a septic systemtest and a water test to make sure the well and water system will maintain anadequate supply of water for the house. Your state may require additional,specific inspections (for example, pest inspections in southern states).Cost range is $175 to $350.
Attorney review/closing fee. The lender will usuallycharge you for fees paid to the lawyer or company that conducts the closing forthe lender.Cost range is $500 to $1,000.
Homeowner's insurance. Your lender will require thatyou have a homeowner's insurance policy (sometimes called hazard insurance) ineffect at settlement. The policy protects against physical damage to the houseby fire, wind, vandalism, and other causes covered by your policy. This policyinsures that the lender's investment will be protected even if the house isdestroyed. With refinancing, you may only have to show that you have a policy ineffect.Cost range is $300 to $1,000.
FHA, RDS, or VA fees or PMI. These fees may berequired for loans insured by federal government housing programs, such as loansinsured by the Federal Housing Administration (FHA) or the Rural DevelopmentServices (RDS) and loans guaranteed by the Department of Veterans Affairs (VA),as well as conventional loans insured by private mortgage insurance (PMI).Insured loans and guarantee programs generally apply if the amount you areborrowing is more than 80% of the value of the property. Both government andprivate mortgage insurance cover the lender's risk that you will not make allthe loan payments.Cost ranges: FHA is 1.5% plus ½% per year; RDS is 1.75%; VAis 1.25% to 2%; PMI is 0.5% to 1.5%.
Title search and title insurance. This fee covers thecost of searching the property's records to ensure that you are the rightfulowner and to check for liens. Title insurance covers the lender against errorsin the results of the title search. If a problem arises, the insurance coversthe lender's investment in your mortgage. Cost range is $700 to $900.
Advice: Ask the company carrying yourcurrent title insurance policy what it would cost to reissue the policy for anew loan. This may reduce your cost.
Survey fee. Lenders require a survey, to confirmthe location of buildings and improvements on the land. Some lenders require acomplete (and more costly) survey to ensure that the house and other structuresare legally where you say they are. You may not have to pay this fee if a surveyhas recently been conducted for your property.Cost range is $150 to $400.
Prepayment penalty. Some lenders charge a fee if youpay off your existing mortgage early. Loans insured or guaranteed by the federalgovernment generally cannot include a prepayment penalty, and some lenders, suchas federal credit unions, cannot include prepayment penalties. Also some statesprohibit this fee. Cost range is one to six months' interest payments.
Define: "No cost" refinancing: Lenders often define "no cost" refinancing differently, so be sure to askabout the specific terms offered by each lender. Basically, there are two waysto avoid paying up-front fees.
The first is an arrangement in which the lender covers the closing costs, butcharges you a higher interest rate. You will pay this higher rate for the lifeof the loan.
Advice: Ask the lender or broker for acomparison of the up-front costs, principal, rate, and payments with and withoutthis rate trade-off.
The second is when refinancing fees are included in ("rolled into" or "financed into") your loan;they become part of the principal you borrow.While you will not be required to pay cash up front, you will instead end uprepaying these fees with interest over the life of your loan.
Advice: When lenders offer a "no cost" loan, they may include a prepayment penalty to discourage you fromrefinancing within the first few years of the loan. Ask the lender offering a no costloan to explain all the fees and penalties before you agree to theseterms.
How to calculate the break-even period - Use the step-by-step worksheet below to give you a ballpark estimate of thetime it will take to recover your refinancing costs before you benefit from alower mortgage rate. The example assumes a $200,000, 30-year fixed-rate mortgageat 5% and a current loan at 6%. The fees for the new loan are $2,500, paid incash at closing.
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| Example | Your |
| Your current monthly mortgage payment | $1,199 |
|
| Subtract your new monthly payment | - $1,073 |
|
| This equals your monthly savings | $ 126 |
|
| Subract your tax rate from 1 | 0.72 |
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| Multiply your monthly savings (#3) by your after-tax rate (#4) | 126 x 0.72 |
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| This equals your after-tax savings | $ 91 |
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| Total of your new loan's fees and closing costs | $2,500 |
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| Divide total costs by your monthly after-tax savings (from #6) | $2,500 / 91 |
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| This is the number of months it will take you to recover your refinancing costs | 27 months |
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If you plan to stay in the house until you pay off the mortgage, you may alsowant to look at the total interest you will pay under both the old and newloans.
You may also want to compare the equity build-up in both loans. If you have hadyour current loan for a while, more of your payment goes to principal, helpingyou build equity. If your new loan has a term that is longer than the remainingterm on your existing mortgage, less of the early payments will go to principal,slowing down the equity build-up in your home.
Refinancing calculator: A mortgage refinance calculator will show the amount you will save compared with the costs you will pay, so that you can determine whether the refinancing offer is right for you.
Shopping for a new mortgage loan - Shopping around for a home loan will help you get the best financing deal.Shopping, comparing, and negotiating may save you thousands of dollars. Begin bygetting copies of your credit reports to make sure the information in them isaccurate.
Talk to your current lender. If you plan to refinance, you may want to start with your current lender.That lender may want to keep your business, and may be willing to reduce oreliminate some of the typical refinancing fees. For example, you may be able tosave on fees for the title search, surveys, and inspection. Or your lender maynot charge an application fee or origination fee. This is more likely to happenif your current mortgage is only a few years old, so that paperwork relating tothat loan is still current. Again, let your lender know that you are shoppingaround for the best deal.
Compare loans before deciding. Shop around and compare all the terms that different lenders offer--bothinterest rates and costs. Remember, shopping, comparing, and negotiating cansave you thousands of dollars.
Lenders are required by federal law to provide a "good faith estimate"within three days of receiving your loan application. You can ask your lenderfor an estimate of the closing costs for the loan. The estimate should give youa detailed approximation of all costs involved in closing. Review thesedocuments carefully and compare these costs with those for other loans. You canalso ask for a copy of the HUD-1 settlement cost form one day before you are dueto sign the final documents.
Tip: If you want to make sure theinterest rate your lender offers you is the rate you get when you close theloan, ask about a mortgage lock-in (also called a rate lock or rate commitment).Any lock-in promise should be in writing. Make sure your lender explains anycosts or obligations before you sign.
Get information in writing. Ask for information in writing about each loan you are interested in beforeyou pay a nonrefundable fee. It is important that you read this information andask the lender or broker about anything you don't understand.
You may want to talk with financial advisers, housing counselors, other trustedadvisers, or your attorney. To contact a local housing counseling agency,contact the U.S.Department of Housing and Urban Development toll-free at 800-569-4287, orvisit the agency online to find a center near you.