Refinancing Process
Step 1: Why Refinance?
There are many good reasons why you may choose to refinance your home. They include:
Of course, lower payments sound appealing. But before you refinance, you need to decide if the cost of the new mortgage is worth the savings. The old recommendation was to refinance only if you could lower your home loan interest rate by at least two percentage points. But now there are other factors to consider. The biggest one is the break-even point. How long will you have to make payments at the lower rate before the cost of refinancing has been paid? If you're going to keep the home for just a short time, say two to four more years, refinancing with no out-of-pocket costs might be a good option. These loans allow you to avoid out-of-pocket payments for lender or third-party fees at closing. Instead, you'll 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. If you think you might stay in your home for another five to seven years, the loan to consider 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 five to seven years. Since you won't be in the home at that point, you'll be out of the loan by then - and won't have to worry about the adjusting interest rates. And you'll have saved a considerable amount on your monthly payments and interest.
Adjustable rate home loans make it easy to purchase a home with low monthly payments. But eventually, the initial low fixed rates gives way to the adjustable-rate period. And these rate adjustments and potential rate hikes can be hard on your budget. If this is your situation, you might want to consider switching to the security of a fixed-rate loan. You'll want to calculate your break-even analysis, which is how low you need to stay in your home to make the costs of refinancing pay off. As long as you stay in your home longer than the break-even point, you'll save money by refinancing. If you plan to be in your home just for a set, shorter number of years, then you may want to refinance with another ARM. You can get fixed period ARMs that start with fixed rates (from three, five, seven or 10 years for the initial fixed rate term), then adjusts yearly after that. Choose an ARM with a fixed-rate term that's longer than you plan on staying in your home. This way, you'll enjoy the lower monthly payments, but will have moved before you hit the adjustable-rate period.
You might have big-expense items on the horizon, such as paying for a child's college tuition or making improvements on your house. By refinancing, you can tap into some of the equity in your home to help pay for these expenses. Another reason you may be interested in taking cash out of your home is to pay off debts that have non-deductible interest costs. The interest on home loan 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 may make sense to use some of the equity in your home to pay off these debts. That way, the interest you pay on your combined debts is now tax-deductible. Before you begin, see your tax advisor or attorney about your particular situation.
If you purchased your home with less than 20 percent down, then you probably have a monthly mortgage insurance payment along with your principal and interest. If you're not sure, check your home loan statement. If you do, you will find a line item specifying the charge. As you make your monthly payments, you eventually reach the point where you have more than 20 percent equity. You may already be there without knowing it. Your home's value may have appreciated because of the favorable housing market or renovations you've done. Your goal for this kind of refinance should be to get a loan without monthly mortgage insurance that has a rate as low as, or even lower than, your current loan.
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