Refinancing Precautions

There are several reasons for an individual to consider refinancing a loan, many of which are discussed below. You should, however, take precaution and consider the pros and cons involved in every circumstance so that you stay well informed. Educating yourself in this way can save you from possible financial missteps and ultimately save you money.

  • Converting an adjustable rate mortgage (ARM) to a fixed-rate mortgage or vice-versa

Rising interest rates can be a determining factor for switching from an ARM to a fixed-rate loan. If you initially settled on an ARM, but you begin to see a steady incline in interest rates it may benefit you to convert to a fixed-rate loan, particularly if you intend to live in your home for several more years.

 

On the other hand, if you initially began with a fixed-rate mortgage and plan to move within a couple of years, you may be able to find a lender who is willing to offer you a dramatic interest rate savings with an ARM, keeping in mind that the interest rate can change after a set interval of time (usually set at a year).

In either case, it is important to consider what the closing costs would be, which lenders offer the best interest rates available, and whether the savings in interest rates outweigh the closing costs.

  • Paying off high-interest loans

Being stuck paying a mortgage on a high-interest loan can really bring on a sense of hopelessness. So little of your monthly payment, initially, goes toward the principle that it seems impossible to build equity in your property. This is when it behooves you to look closely and take advantage of a buyer’s market. A lender who will pay off that high-interest loan and offer you a significantly lower rate of interest will be exactly what you need to shop for. It is important to consider the difference between current interest rates and the rate of your original loan. Does the amount of time it will take to recoup the costs of refinancing make refinancing worth it? Evaluate your response… especially if you want to sell your home in the near future.

  • Lowering monthly mortgage rates

Sometimes, through unforeseen circumstances, the motivation for refinancing is to reduce monthly payments on a loan. Although it is not a move that is often encouraged, it is sometimes necessary. If you find yourself in this situation, make sure you are asking several lenders for their best offers on interest rates… the lower, the better. Lowering your monthly payments may mean that you also need to make your loan for 30 years instead of what may have originally been a 15 year mortgage. This can be helpful in reducing your monthly payments, but will eventually cost more for you by the end of your mortgage period. Again, check with each lender to work out the least expensive closing costs on your new loan.

  • Raising cash for family expenses (i.e. College tuition, or home improvements)

If you’ve built enough equity, you can refinance in order to take cash out of the property. Perhaps you need money to pay off your credit cards, add a new bathroom, or cover the costs of braces for a child. Despite the reason, lenders will typically allow you to borrow against the equity you’ve built in your house, plus appreciation (often up to 75 percent of the current appraised value). These types of loans are also called home equity loans.

 

Be cautious, however, of lenders offering 100 percent or 125 percent home equity loans. Their rates are often markedly higher than traditional lenders. In addition, any amount you borrow that is above the market value of the house is NOT tax deductible.

Do your homework before deciding to refinance.

  • As a rule

A rule of thumb, as to whether it is a good time to refinance, is if interest rates fall more than two percent below that of your existing loan. That’s because refinancing usually involves most of the same closing costs (loan origination fee, prepaid interest, etc.) as the original loan. For anything less than two percent, the savings on your monthly mortgage payment may not be sufficient to make up those closing costs.

  • Breaking even

For some homeowners, though, the two percent rule is not as important as the time needed to break even on the refinancing. Suppose it costs $3,000 to refinance a house, and the monthly mortgage payment is lowered by $90, it would take almost 3 years for the savings to cover the costs of refinancing. This is acceptable if your intention is to stay in that home for at least three years, but if not, it would be no benefit to you.

  • Ask the lender

If all the information (survey, title search, etc.) for your old loan is still current, however, the lender may be willing to waive many of the closing fees. In addition, you may be able to roll the closing costs of a refinance loan into the new note. In other words, you don’t avoid the closing costs, but instead pay them back over time along with the rest of the loan. If you consider this option, be sure to calculate the potential savings against the expense of paying off a higher principal balance.

  • Weigh your options

Keep in mind that refinancing usually lengthens the time it takes to pay off your house. If you are 3 years into a 30-year mortgage and then refinance with a new 30-year loan, you’ll end up making payments on the house for 33 years. Nevertheless, if the monthly savings are substantial enough, you still could end up paying much less over the long haul with the new loan.

  • Regarding home equity

Refinancing with a new loan doesn’t mean you have to give up all the money you’ve paid toward your old mortgage. With each payment, you build up a certain amount of equity (the amount you have paid on the principal balance of the loan). For example, if you have a $100,000 loan at 8 percent, you would build about $2,800 worth of equity in the first 3 years. Thus, if you refinanced, the new loan would only amount to $97,200.

  • Lenders Will Be Glad To Talk To You

In your quest to stay well-informed, be sure to take full advantage of the data that a potential lender can provide by asking lots of “what if” questions. With all the different types of refinancing loans available today, you would benefit by speaking with several lenders before making a decision. Be sure to discuss all the expenses and benefits, as well as what will be expected of you, in advance. The more you educate yourself, the better your chances of finding the right refinancing package.

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