If you own your home, there’s a 60% chance that you have a mortgage on that home. Do you know what interest rate you have on that mortgage? Well you should because the interest rate environment changes over time and you could be giving away free money to your lender. So how does refinancing a mortgage work? It’s much like the process when you first bought your place. You want to find a lender whom you trust and ask them for current rates and terms which you then compare to your current loan to see if makes sense to refinance. Typically, your new loan will replace your old loan so it’s not like you will be carrying 2 loans, again typically. Sometimes the results of the comparison is a no-brainer, other times you may need to take a deeper dive and also consider what your future plans are for your home. Your lender should be able to provide guidance as well as your CPA.
Remember what it meant to qualify for your loan, well you’re going to have to do that again. And just like last time, your lender is going to look at your credit history and score, your timeliness of payments on current loans, your income and employment history, your other debt and related payments, current home value and equity in that home.
Why would you want to refinance?
The most popular reason to refinance is for a lower interest rate and payment. If your credit has gotten better and/or interest rates have gone down, you may be able to reduce your monthly payments and save on interest.
Another reason may be to cash out. You can refinance with a larger loan so that you can use those funds for something else like finance a big purchase, pay bills or your child’s college tuition. We call this tapping into your ‘lazy’ equity. Lazy from the mindset that the equity building up in your home isn’t working for you generating income like investment property or a stock portfolio. Cash out refinancing is actually part of a great investment strategy that I’ve used before where investors buy properties cash, fix it up, then cash out refinance to get their initial investment back.
A third reason to refinance would be to change your rate type. Some homebuyers start off with an adjustable rate mortgage or ARM and they want to move to a fixed rate mortgage.
Yet another reason to refinance would be to change the loan term. Loans with shorter terms typically have lower interest rates. As such you’ll be paying off your loan quicker, also paying less interest over the life of the loan.
Here are 3 Things to consider when refinancing:
#1 break even points:
When in doubt, have your lender calculate a break-even point for you. Whether it be deciding if it makes sense to pay points for a lower rate, or rolling closing costs into the loan, or even if you should refinance at all, take a look at your break-even point to help you decide on your options. In part 2 of this blog I’ll go into more detail on, “should I refinance my home now?”
#2: Home Equity Line of Credit
Have you considered a HELOC? If your new loan amount is manageable, consider refinancing to a home equity line of credit. Remember that a HELOC rate is not fixed, however, interest is calculated on simple interest versus the amortized interest of the 30-year fixed rate loan. HELOC’s may also give you more flexibility for your working capital and further tapping into your ‘lazy equity’ I mentioned earlier.
#3 Effects of a Cash out Refinancing:
Cash out refinancing typically INCREASES your monthly payments. Be careful on why you’re tapping into the equity. If someone tells me they’re going to use the cash to buy a 1986 Michael Jordan Rookie card or a Hermes Birkin bag they otherwise could not afford, I probably wouldn’t promote that. If they tell me they going to use it for improvements to their house, that would sound a little better to me. If they told me they were going to use the proceeds for an investment opportunity like a business or real estate, that would get me excited and giddy.
So that’s how refinancing works. Feel free to contact me if you have any questions. Also read part 2 of this blog, “Should I Refinance My Home Today?”
BONUS Topic: 2 alternatives for refinancing:
Alternative #1 – For HELOCs: If you have a home equity line of credit and you’re promotional rate of 1 % for one year is running out, ask your lender for a bridge rate that will be better than the rate it is supposed to reset to, but it won’t be as good as the promotional rate. Remember, the lender doesn’t want you to refinance out to another bank.
Alternative #2 – For fixed rate mortgages: If you are satisfied with your current rate and terms but want to pay down your loan and also reduce your monthly payments, consider RECASTING your loan. To recast your loan, talk to your lender about how you can do this. Basically, you pay a few hundred dollars to the lender, you pay down a chunk of the principal of the loan balance, keep the rates and terms, but reduce your monthly payments. Sometimes this is a great alternative to a cash in refinance.
