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Reasons to Refinance
February 5th, 2008If you are considering refinancing your mortgage you might wonder what valid reasons are for taking out a new home loan. There are a number of different reasons people choose to refinance their mortgage loans; with mortgage rates at the lowest levels since 2004, now is the perfect time for you to get a new home loan. Here are several tips to help you decide if mortgage refinancing is right for you and to show you how to avoid paying too much for the new loan.
Why Refinance Your Mortgage?
The most common reason for refinancing is to secure a lower monthly payment. In order to lower your payment you first have to qualify for a lower mortgage rate…how much lower depends on your situation.
You may have heard of the so called “two percent rule” of mortgage refinancing; this rule says you should not refinance unless the new mortgage rate is two percent lower than your current rate.
This “two percent rule” is complete rubbish…you can save yourself a lot of money refinancing with a rate less than two percent…it just depends on how long it takes to recoup your expenses form refinancing. You can easily determine how long it will take to recoup your expenses if you know the new payment amount. Simply divide your total closing costs including any penalty you have to pay for early repayment by the difference between the new payment and the old payment amounts. This will tell you the number of months it will take you to recoup your expenses from refinancing your home loan and realize a savings.
Lower Payments Are Not The Only Reason
There are cases where it makes sense to refinance with a higher monthly payment. If your goal is to build equity in your home at a faster rate you could refinance with a shorter term length in addition to qualifying for a lower mortgage rate. While this would get you a higher payment you would be paying less to the lender in finance charges and would build equity in your home at a much faster rate.
Other reasons for refinancing to a higher monthly payment include borrowing against your home equity. Refinancing your home loan and taking cash back is generally cheaper than taking out a home equity loan or line of credit. Since you’re borrowing against the equity in your home you can use the cash for any reason and have the advantage of making one monthly payment instead of two with a home equity loan.
Watch Out For Garbage Fees
Once you’ve decided that mortgage refinancing makes sense you’ll need to be careful to avoid garbage fees and commission based markup of your mortgage rate. Taking out a mortgage is a lot like buying a used car…if you’re not careful it’s easy to overpay thousands of dollars for your new mortgage loan. You can learn more about your mortgage refinancing options including costly pitfalls to avoid by registering for our free mortgage video tutorial.
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There’s not really any single reason we could point to that explains why the housing market/ lending industry has been through such an upheaval. Certainly rapidly rising home prices had something to do with it. And the rise in risky loans, like interest-only and subprime loans played a part, too.
But the unwise use of home equity was a problem, too.
Home equity is the difference between the market value of your home and the amount you owe on it. For example, if your home is market valued at $300,000 and you currently owe (including all mortgages and equity loans or lines of credit) $280,000, then you have $20,000 – or about 7% – in equity.
As home values rose rapidly, shady loan officers convinced homeowners to take out 100% (or more!) home equity loans on their homes. If home values had risen 20% (as they did in many areas of Phoenix), even a homeowner who bought a home with no money down could take out a huge home equity loan.
Sometimes, instead of taking a home equity loan, which is a second mortgage, or a home equity line of credit, which is like a credit card with your house as collateral, people did a cash-out refinance, where they refinanced their homes, got a new adjustable-rate mortgage for 100% of the home’s value, and took the equity in cash to spend.
At the time, it all sounded like a great idea. Some people used the cash to take trips they’d been waiting for their whole lives for. Others paid off high-interest debt like credit cards.
But as home values fell, people found themselves owing more on that new mortgage or combined mortgage and home equity loan than their house was worth. And for those who did cash-out refinances with adjustable rate mortgages, many of those rates are resetting to much higher interest rates (and, consequently, much higher monthly payments).
It’s true, as the NAR has been saying, that a home is the most substantial form of wealth that most Americans have. And using the equity in our homes to get cash for other uses can be a fine idea. But it’s not always. Here, it’s borrower beware.