Home ownership can be for many their biggest financial asset, and as a result, biggest financial concern. But with current mortgages dropping to their lowest point since the 1950s, many Silicon Valley homeowners are saving thousands a year just by refinancing. Is the time right for you? Let’s go through some considerations that cover the why, how, and hurdles of refinancing.
- Why refinance?
- Hurdles in refinancing
- Break-even calculation
- Comparing interest rates Shopping for a new mortgage
The most common and obvious reason is that homeowners refinance to lower their mortgage rate. A lower rate means lower monthly payments and less money towards interest over the life of the loan.
For example, a 30-year fixed-rate loan of $400,000 at 6% would have a monthly payment of $2,398. But if you were to qualify for 5.5% on the same loan amount, your monthly payment would be $2,271, or a savings of $127 a month and $1,524 saved in a year.
Or you may want to adjust the term of a loan. Decreasing the time period of a loan results in a lower rate and paying off your loan sooner, for a slightly higher monthly cost compared to a 30-year loan. Increasing the length of a loan is a cash-flow option, freeing up cash now, but paying more over time.
You can also switch between an adjustable-rate mortgage (ARM) and a fixed-rate mortgage. The riskier ARMs float with current interest rates, so your payments increase or decrease accordingly. Commonly, homebuyers are moving to a safer fixed-rate mortgage.
Cash-out is the last option, where you refinance a mortgage for more than you owe and receive equity in cash, which can help pay for large debts now.
Options outside of refinancing are home equity loans and lines of credit, and reverse mortgages.
Common hurdles when refinancing
Before you think a refinance is the easiest route to saving your financial back, strict requirements and sometimes extra costs don’t make the trip worth it.
Similar to the first time you applied for a mortgage, lenders are looking at three qualifications: income, credit score, and property value. If any one of these has suffered, lenders will likely charge additional fees or raise your rate.
Another issue can be if your current mortgage has a prepayment penalty, which reduces the benefit of refinancing, again, because of additional costs.
So talking to a loan officer is the first step to see where you fall financially and what you qualify for in terms of refinancing your mortgage.
How long it takes to recoup the cost of refinancing realized with a lower rate, the break-even point, is useful for determining if it is worth refinancing when considering how long you plan to stay in your home.
Typical fees that add to the cost of refinancing are loan origination fee, points paid to lower your interest rate, appraisal fee, inspection fee, closing fee, title search and title insurance, and other miscellaneous lender fees. Total fees can easily get into the thousands.
Lenders sometimes offer “no-cost” refinancing. Though you may not have to pay the above fees at closing, you will have to either accept a higher interest rate or the fees will be rolled into the term of the loan.
If you leave your home before recouping the closing costs there is little point in refinancing.
Let’s use our previous example, and say a refinance will save you $127 a month but closing costs were $4,500. To break-even, you would have to keep the loan for about three years; if you were to keep the house for 10 years you would save $10,720, including the cost of closing.
There are numerous refinancing calculators on the Web, like at bankrate.com, where you can plug in your own finances and get a quick estimate.
Comparing interest rates
As we saw with the initial graph, rates have been dropping over the years. But interest rates and fees change daily from lender to lender.
In addition to the most surefire ways -- good credit, income, and equity -- to an excellent rate you can also pay points. A point is equal to 1% of the total loan amount and the more points you pay the lower the rate.
To give you an idea of the current rates for a 30-year mortgage, here are some from a Bay Area lender as of July 2010:
No point, conforming loan (under $417,00) = 4.5% No point, “no-cost” conforming loan (under $417,00) = 4.75% High-balance loan (under $729,250) = .125% - .25% higher than a conforming Jumbo loan (anything higher than $729,250) = low-to-mid 5s
Shopping for a new mortgage
Shopping around and comparing loan offers by different lenders is the best way to save money. First, talk to your current lender, as they could save you time and wave fees since you are a returning customer.
Feel free to contact us if you are looking for recommendations on Bay Area lenders or mortgage brokers; also, if you would like to find out more about our real estate services. _