June 9, 2017

Refinancing

Refinance Process

Refinancing a mortgage is the process of acquiring a new loan to pay off an existing lender.

Four Possible Reasons To Refinance

A mortgage is generally the largest debt most homeowners have to manage.  It’s a good idea to give your personal real estate finance portfolio a check-up at least once a year.

Since there are many reasons a homeowner may choose to refinance, we’ll take a look at the four most common.

1. Interest Rates Will Drop

Typically, the most common reason that homeowners refinance their mortgage is to secure a lower interest rate. Interest rate and loan amount determines the total cost that a borrower will pay. The lower the interest rate, the less the overall cost will be. Interest is calculated on a daily basis and usually paid back to the lender on a monthly basis.

2. Lower Payments

Lowering a mortgage payment can be achieved by lowering the mortgage rate, lengthening the loan term, combining two or more loans or removing mortgage insurance.

3. New Mortgage Program

Refinancing an Adjustable Rate Mortgage (ARM) to a new Fixed Rate Mortgage (FRM), combining a first and second mortgage or paying off a balloon loan are three possible reasons to explore a refinance.

4. Debt Consolidation

If there is sufficient equity, sometimes paying off consumer debt by combining all debts into one lower monthly mortgage payment can significantly reduce the short-term deficits in a budget.
However, it’s important to keep in mind the total cost of that debt by adding it into a 30 year mortgage payment.

Frequently Asked Refinance Questions:

Q:  Do I have to refinance with my current mortgage company? No, you may choose any company to refinance your mortgage since the new loan will replace the existing mortgage.

Q:  Is it easier to refinance with my current mortgage company? It is possible your current mortgage company may require less documentation, but this could add additional cost or a higher interest rate. Do your homework and shop around to make sure you’re getting the best deal.

Q:  Will I automatically qualify if I’ve never made any late payments? No, you will have to qualify for your new refinance. However, certain programs will allow for reduced documentation like a FHA to FHA Streamline Refinance.

Calculating the Net Benefit of a Refinance

Calculating the net benefit of refinancing can be a challenging task if you do not understand what to calculate. We are going to focus on the net benefits of refinancing from the standpoint of lowering your interest rate.

Although there are several reasons to refinance, lowering your mortgage rate to save on interest payments over the term of the loan is the most popular. Calculating the actual savings can be a tricky chore unless you know the difference between cash flow savings and interest savings.

If your refinance objective is to only save on the interest by lowering your rate, then the interest savings should be done with the calculations below.

Calculating Interest Savings

(Loan Amount x Interest Rate) / Months in year = Interest paid per month ($200,000 x 6% or .06) / 12 = $1,000.00 *Remember to do the calculation in the parentheses first*

We now know that you are paying $1,000.00 per month in interest. You should take the new interest rate you are getting with your refinance and calculate what your new interest payment will be. ($200,000 x 5% or .05) / 12 = $833.34

Now we need to find out the difference between the two interest rates. Current Interest Payment – Proposed Interest Payment = Interest Savings $1,000.00 – $833.34 = $166.66

Now you have figured out that by dropping your interest rate 1% on $200,000 you will be saving $166.66 per month or about $2,000 per year. Awesome! Anyone would want to save $2,000 per year, where do I sign… right?

Not so fast, you’ll want to calculate the break-even point to find out how you will benefit after your closing costs.

Net Benefit Formula

(Closing Costs – Escrows) / Interest Savings = Month of Break-Even ($6,000 – $1,000) / $166.66 = 30 Months In other words, it will take 30 months for you to recoup the cost of your refinance.

If you plan to keep your mortgage for at least 30 months then you might want to consider this deal. Okay, now we can calculate your net benefit for refinancing with one more calculation. (Monthly Savings * Months you plan to keep mortgage) –

(Closing Costs –Escrows) = Net Savings ($166.66 * 120 months) – ($6,000 – $1,000) = $14,999.20

If you kept the mortgage for 120 months (10 years) you would save $15,000.

Okay, now you can find out where to sign. Calculating the net benefits of a refinance is crucial in determining if it is strategic for you to refinance. Keep in mind that each mortgage is slightly different and you may need to adjust calculations accordingly.

Frequently Asked Questions:

Q:  I heard that I should only refinance if I drop 1% on my mortgage is that true? Some people say ½% , 1% to never. Every mortgage is different.

For Example: A no cost loan can have a 1 month break-even point with only a .25% drop in interest rate. Now that you know how to calculate your net benefit, you are able to figure out what may be best for your situation.

Q:  Why can’t I just compare my current payment to the proposed payment and figure out my net benefit? You could just compare just the two payments if you wanted to find out your cash flow savings, but the current and proposed loans may have two different amortizations.

Let’s assume you currently have a 15 year mortgage and you’re comparing it to a 30 year mortgage. If both loans have the same interest rate and loan amount but the amortization is different, your interest savings per month would be $0. However, you are going to show a cash flow savings with the 30 year mortgage because of the longer amortization.

Should I Get A Home Equity Line of Credit or Cash-Out Refi to Make Home Improvements?

For homeowners interested in making some property improvements without tapping into their savings or investment accounts, the two main options are to either take out a Home Equity Line of Credit (HELOC), or do a cash-out refinance.

A Home Equity Loan is similar to the line of credit, except there is a lump sum given to the borrower at the time of funding and the payment terms are generally fixed.

Both a Line and Loan would hold a subordinate position to the first loan on title, and are typically referred to as a “Second Mortgage.”

Since second mortgages are paid after the first lien holder in the case of default foreclosure or short sale, interest rates are higher in order to justify the risk.

Fees, Interest Rate, and Timeline are the three main factors to consider which option to choose in order to pull equity out of a property.

Measuring The Different Between HELOC vs Cash-Out Refinance:

There are three variables to consider when answering this question:

1.  Timeline
2.  Costs or Fees to obtain the loan
3.  Interest Rate

Timeline

This is a key factor to look at first, and arguably the most important. Before you look at the interest rates, you need to consider your time line or the length of time you’ll be keeping your home. This will determine how long of a period you’ll need in order to pay back the borrowed money.

Are you looking to finally make those dreaded deferred home improvements in order to sell at top dollar? Or, are you adding that bedroom and family room addition that will finally turn your cozy bungalow into your glorious palace?

This is a very important question to ask because the two types of loans will achieve the same result – CASH — but they each serve different and distinct purposes.

A home equity line of credit, commonly called a HELOC, is better suited for short term goals and typically involves adjustable rates that can change monthly. The HELOC will often come with a tempting feature of interest only on the monthly payment resulting in a temporary lower payment. But, perhaps the largest risk of a HELOC can be the varying interest rate from month to month. You may have a low payment today, but can you afford a higher one tomorrow?

Alternatively, a cash-out refinance of your mortgage may be better suited for securing long term financing, especially if the new payment is lower than the new first and second mortgage, should you choose a HELOC. Refinancing into one new low rate can lower your risk of payment fluctuation over time.

Cost/Fees

What are the closing costs for each loan? This also goes hand-in-hand with the above time line considerations. Both loans have charges associated with them, however, a HELOC will typically cost less than a full refinance.

It’s important to compare the short-term closing costs with the long-term total of monthly payments. Keep in mind the risk factors associated with an adjustable rate line of credit.

Interest Rates

The first thing most borrowers look at is the interest rate. Everyone wants to feel that they’ve locked in the lowest rate possible. The reality is, for home improvements, the interest rate may not be as important as the consideration of the risk level that you are accepting.

If your current loan is at 4.875%, and you only need the money for 4-6 months until you get your bonus, it’s not as important if the HELOC rate is 5%, 8%, or even 10%. This is because the majority of your mortgage debt is still fixed at 4.875%.

Conversely, if you need the money for long term and your current loan is at 4.875%, it may not make financial sense to pass up an offer on a blended rate of 5.75% with a new 30-year fixed mortgage. There would be a considerable savings over several years if variable interest rates went up for a long period of time.

Choosing between a full refinance and a HELOC basically depends on the level of risk you are willing to accept over the period of time that you need money.

 

Frequently Asked Questions:

Q:  Is there such a thing as a “No Cost” mortgage?

Technically speaking, there are always costs involved with any mortgage transactions.  Appraisal, inspection, underwriting, prepaid taxes, insurance, interest….  the list can go on.

However, there is a way to structure a closing cost and interest rate scenario that will decrease the amount of fees, or how a borrower pays them.

Basically, the costs to produce the new mortgage are either financed into the loan amount, or covered by the lender in exchange for a slightly higher than market interest rate.

Deciding on the best option involves weighing the difference in cost up-front vs the increased monthly payment over a set period of time.

Q:  How long do I have to wait to refinance after a purchase transaction?

The rule-of-thumb is 8-12 months, but there may be exceptions.  It’s important to check with your lender at the time of initial application to make sure there aren’t any short-term penalties for refinancing within the first year.

Another thing to consider is the cost of refinancing.  If you’re watching the market and may want to lock in a lower rate in the near future, it may be more cost effective to pay a discount point for a lower rate vs paying for a full refinance a few months later.

Q:  I heard that I should only refinance if I drop 1% on my mortgage, is that true?

Some people say ½%, 1% to never. Every mortgage is different.

Q:  Why can’t I just compare my current payment to the proposed payment and figure out my net benefit?

You could just compare just the two payments if you wanted to find out your cash flow savings, but the current and proposed loans may have two different amortizations. Let’s say you have a 15 year mortgage currently and you are comparing to a 30 year mortgage.

If everything else is the same (interest rate, loan amount, etc) except for the amortization your interest savings per month would be $0 but, you are going to show a cash flow savings because of the longer amortization.

Q:  Do I have to refinance with my current mortgage company?

No, you may choose any company you wish to refinance your mortgage since the new loan will replace the old mortgage.

Q:  Is it easier to refinance with my current mortgage company?

Sometimes your current company can reduce the documentation that is required, but this usually comes at increased costs and interest rate. Make sure that you check to make sure you’re getting the best deal.

Q:  Will I automatically qualify?

No, you will have to qualify for your new refinance. However certain programs will allow for reduced documentation like the FHA to FHA Streamline.