Mortgage Refinancing
Mortgage refinancing sounds complicated and even frightening if you don’t know anything about it. Simply put, mortgage refinancing is when you replace one mortgage with another. This is done to take advantage of a lower interest rate that has become available since you first took out your mortgage. On the face of it this is a good idea. If you are considering mortgage refinancing, make sure that you do your sums. There are expenses involved that may cancel out the benefits that you get from mortgage refinancing.
Consider this before you take out a remortgage:
To obtain a lower fixed rate.
If you took out a fixed-rate mortgage several years ago and interest rates have since dropped, refinancing may lower your payments considerably. A $150,000 mortgage with a 30-year term and a rate of 8 percent, for example, carries a monthly payment of $1,100. The same mortgage at 6 percent will have a payment of less than $900 a month.
To switch to a fixed rate or an adjustable rate mortgage.
Adjustable-rate mortgages (ARMs) offer lower interest rates initially, but some homeowners find the fluctuations stressful. If rates are on the way up, you might consider locking in at a fixed rate and consistent monthly payment. On the other hand, if you want to reduce your monthly payments and are comfortable with the interest rate changes of an ARM, it could save you money to refinance to an ARM.
To improve the features of your ARM.
Mortgages with adjustable rates have protective caps that limit how much your payments can increase in any given year and over the full term of the loan. You may be dissatisfied with the caps on your current ARM and feel you can negotiate more favourable features if you refinance.
To build your home equity faster.
If a recent change in your financial situation has made it possible for you increase your monthly payments, you might want to refinance your mortgage with a shorter term. The higher payments will enable you to pay off your home more quickly and to save substantially on long-term interest charges. However, if you are disciplined you can also opt not to refinance and simply pay more towards your principal each month.
To reduce your monthly payments.
Refinancing for a longer term will lower the amount you have to pay each month. You will end up paying more in interest charges over the life of your loan, but if you're having difficulty making your current payments, this strategy could provide some relief.
To turn home equity into cash.
You may want to take out a new mortgage with a larger principal, in order to turn some of your home equity into cash for a major expense. This is called cash-out refinancing. The advantage of taking out a loan secured by your home is that you can get a lower rate of interest than you can with an unsecured loan or credit card. However, if the interest rate offered for your refinanced mortgage is higher than your current rate, a home equity loan or line of credit might be a better choice. Is mortgage refinancing right for you?
If you're refinancing in order to pay less interest, you won't usually see the savings right away. That's because lenders typically charge fees when you take out a new mortgage, and you may also have to pay a penalty for getting out of your old one.
To determine whether mortgage refinancing makes financial sense for you, consider these issues:
How long you plan to be in your home? If you expect to move in a year or two, you may never realize the potential savings you'd get from refinancing. As a rule of thumb, the longer you plan to stay in your current home, the more sense it makes to refinance.
The prepayment penalty on your current mortgage. Many mortgages carry a penalty if you pay them off early. The amount varies, but it is usually a small percentage of the outstanding balance, or several months' worth of interest payments.
The costs of the new mortgage. When you take out a new loan, your lender may charge a number of fees including application, appraisal, origination and insurance fees, plus title search, insurance and legal costs that can add up to thousands of dollars. Lenders may also charge discount points, which are paid upfront to secure a lower interest rate. As a guideline, expect fees to eat up any potential savings unless your new interest rate is at least a half a percentage point lower than your current one.
The true difference in borrowing costs. When you're considering refinancing, remember that the posted interest rate doesn't reflect the entire cost of the mortgage. The amount you pay over the life of the loan will also be affected by the length of the term, whether your rate is adjustable or fixed, whether you paid discount points, and what upfront and ongoing fees you incur. One way to compare mortgage costs is to look at the annual percentage rate (APR), which takes into account not only the base interest rate, but also points and other charges. All lenders must follow the same rules when calculating the APR, so it's a good basis for comparison.
Your reduced tax savings. If you claim mortgage interest on your tax return, refinancing to a lower rate will mean that you'll have less mortgage interest to deduct. You will still save money overall, but your real savings from refinancing may not be as large as you first believed. Consult a tax advisor who can help you understand the tax implications of refinancing.