Beware Refinancing Mistakes
Refinancing to lower your monthly payments
Who doesn't want lower payments? The real question here is whether the cost of
the loan is worth the savings.
Let's look at an example. Say you have a 30-year fixed rate loan at 9.5% and
the current rate for the same loan is 8% — should you refinance for a
lower payment?
The old advice was to refinance only if you could lower your home loan interest
rate by at least 2 percentage points. But today there are a variety of other
things to consider before you decide.
If you're going to keep the home for just a short time, say 2 to 4 more years,
refinancing with no "out-of-pocket" costs might be a good option. These loans
allow you to avoid "out-of-pocket" payment for lender or third-party fees at
closing. Instead you pay a slightly higher interest rate over the life of the
loan to cover these costs. Because you'll only pay the higher rate for a short
time, the extra interest is less than you would have paid "out of pocket."
But let's say you're thinking of staying in your home at least another 4 years.
Then the most important calculation is the break-even point — how long do
you have to make payments at the lower rate before the cost of refinancing has
been paid?
 | | | | | | | | | | | | | | | | | | | $97,960 (originally borrowed $100,000) |
| | | $99,960 ($97,960 + $2000) |
| | | | | | | Closing Costs Rolled into Principal Balance |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Principal/Interest Payment |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 18.35 months ($2000 cost divided by $109 in monthly savings) |
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NOTE: These sample loans are for illustration purposes only and are not a rate quote, pre-approval, or commitment to lend.
In this example, it makes sense to refinance because you break even in less than
19 months, comparing monthly payments and principal payment based on the
amortization schedules. In other words, the savings you achieve in the proposed
refinance offset the closing costs in less than 2 years.
Think you might stay in your home for another 5 or 7 years? The loan to consider
here might be a fixed period Adjustable Rate Mortgage
(ARM) that starts with a fixed rate and converts to an ARM at the end of the 5
or 7 years. Since you won't be in the home at that point, you'll be out of the
loan by then. And you'll have saved a considerable amount on your monthly
payments and interest.
With so many ways to lower your monthly payment, how do you pick the right one
for your situation? Call us right now from any place in Florida at Orlando: 407-625-4292 Miami: 305-407-3547 for some free advice.
NOTE: Relative benefits of the alternatives described above will vary over time and depend on individual circumstances.
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Refinancing for the security of a fixed rate loan
An adjustable rate mortgage is a great way to get into a home with low monthly
payments. But the periodic rate adjustments and possibility of rate hikes can
be disconcerting. Which is why you might want to consider switching to the
security of a fixed rate loan.
Here again, you have different options for every situation.
Plan to be in your home just for a set number of years? You can get fixed period
ARMs that start with fixed rates (from 3, 5, 7 or 10 years for the initial
fixed rate term), then the rate adjusts yearly after that. If you stick to your
plan, by the time the loan would have converted to an ARM, you'll have already
moved. A tip: the shorter the initial fixed rate period, the lower your
interest rate.
If you're planning to be in the home for a long time, consider a fixed rate loan
with a term of 15, 20, 25 or 30 years. Just remember, fixed rate loans may have
a higher rate than what you're currently paying for your ARM. So you want to
carefully consider both how long you plan to stay in your home and how
important the security of a fixed rate loan is to you.
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Refinancing to move to an ARM for short-term savings
A lot of people might wonder why you would want to go from a fixed rate loan to
an ARM. But it can be a smart move if you want to save money on your home loan
payments for a year or so before moving to another home.
By switching from a fixed rate loan to an ARM, you can save substantially in the
short term. One option is to get a "no out-of-pocket
costs " ARM. This will mean a slightly higher interest rate, but
since your goal is to save and conserve cash, closing costs are an expense you
don't want. You want savings on your payment now.
How much can you save? That depends on your current loan, the ARM you choose and
today's rates. Here's an example.
| | | | | | | | | | | | | | | | | | | $97,960 (originally borrowed $100,000) |
| | | $99,960 ($97,960 + $2000) |
| | | | | | | Closing Costs (to be rolled into principal balance) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Principal/Interest Payment |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 8.55 months
($2000 cost divided by $234 in monthly savings) |
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These sample loans are for illustration purposes only and are not a rate quote, pre-approval, or commitment to lend.
In this example, it makes sense to refinance because you break even in less than
1 year. And if you stick to your plan, you move before the rate adjusts. This
demonstrates how an ARM can be a great short- to intermediate-term solution for
lowering your monthly payment.
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Refinancing to take cash out of your home's equity
The home loan payment you make each month increases the
equity you have in your home. This equity can represent a substantial
part of your savings. By refinancing, you can free up some of this money for
other purposes. You might need it for a child's college tuition. Or to invest
in a second home.
Another good reason to take cash out of your home is to pay off debts that have
non-deductible interest costs. The interest on home loans is, in most cases,
tax-deductible. If you have a sizeable amount of debt in non-deductible loans,
such as credit cards and car loans, it can make sense to use some of the equity
in your home (provided you have enough) to pay off these debts. That way, the
interest you pay on your combined debts is now tax-deductible. (See your tax
advisor about your particular situation.)
To draw out cash from your home, you can typically borrow up to 75% of the
appraised value. At Approved Mortgage, we have an expanded cash-out program that
allows you to borrow up to 90% of the appraised value of your home.
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Refinancing to eliminate mortgage insurance
Did you purchase your home with less than 20% down? Then you probably have a
monthly mortgage insurance payment along with your principal and interest.
(Check your home loan statement if you're not sure.)
As you build equity in your home, you eventually reach the point where you have
more than 20% equity. You may already be there. In fact, in a favorable housing
market where home values are increasing at above average rates, your home's
worth may have increased to the point where you have 20% equity simply because
your home has become more valuable. But you may not be able to cancel your
mortgage insurance yet.
Your goal for this kind of refinance should be to get a loan without monthly
mortgage insurance that has a rate as low or an even lower than your current
loan. The ideal situation would be to reduce your rate by more than just the
cost of your monthly mortgage insurance payment alone.
NOTE: Home equity loans not available in some states.
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Beware Refinancing Mistakes
