How to Refinance a Mortgage

Are you a homeowner in need of cash and are considering taking out equity in your home? Borrowing against your home’s equity is a way to consolidate bills, pay medical or educational expenses, or make home repairs. Understanding the different types of home equity loans will help you avoid paying too much for the financing; here are several tips to help you decide if borrowing against your equity is right for you.

Cash Out Mortgage Refinancing

Refinancing your home with cash back means taking out a new mortgage to pay off your existing loan while borrowing more than the payoff balance of your loan. The difference between your payoff balance and the amount you borrow will be paid to you in cash at closing. Cash back refinancing is great for homeowners who have a significant amount of equity to borrow against or if you need to improve the terms of your existing mortgage. It is important to remain in your home long enough to recoup the expenses from refinancing your existing mortgage.

Second Mortgage Loans

Taking out a second mortgage will get you a higher interest rate than if you were refinancing with cash back. The reason for this is that your home will be secured by two loans often from different lenders. The second lender shoulders more risk than the first and will pass that risk on to you the borrower with a higher mortgage rate. Second mortgages cost less in upfront fees than refinancing; however, because the loan is secured by your home the rates are typically lower than signature loans or credit cards.

Home Equity Lines of Credit

Using a Home Equity Line of Credit allows you to borrow as you need money and have the advantage of paying interest only on the loan’s balance. A home equity line can be an extremely flexible and many offer debit cards for ease of access to your funds. There is additional risk involved with a Home Equity Line of Credit as the ease of access to your equity may result in borrowing more than you intended. If you have difficulty managing your money this might not be the best loan for you.

Tax Deductible Interest

The interest you pay on cash out refinancing or home equity loans is typically tax deductible. If you borrow more than your home is worth or if you have second mortgages for more than $100,000 the IRS could deny your deduction.

Is a Home Equity Loan Right For You?

Make sure the reason you are borrowing warrants dipping into your equity. While the equity in your home belongs to you, it doesn’t make sense to borrow for something like a vacation or to purchase an automobile. If you need cash for some financial goal or to make improvements to your home or even start a business, cashing out your equity could be a wise financial decision. Remember that your home should not be the piggybank you dip into whenever you need a cash fix.

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If you are a homeowner paying on an Adjustable Rate Mortgage, refinancing could help you avoid a financial nightmare. Many homeowners don’t know when their Adjustable Rate Mortgages are scheduled to reset and experience payment shock when their monthly payment goes up by several hundred dollars. Here are several tips to help you manage your Adjustable Rate Mortgage and decide if refinancing is right for you.

Many homeowners use Adjustable Rate Mortgages to purchase their homes because these loans are easier to qualify for and have lower payments, at least in the beginning. These loans frequently come with ultra-low “teaser” interest rates; however, at the end of the introductory period the loan switches to the contract mortgage rate and the payments go up significantly. Homeowners who don’t understand how their contracted mortgage rate works can experience payment shock when their lender starts adjusting the loan.

What is Mortgage Payment Shock?

Imagine waking up one day to a statement from your lender showing that your Adjustable Rate Mortgage has reset and the new monthly payment will be $400 more than you’re currently paying. For many homeowners living paycheck to paycheck this would be a disaster resulting in the eventual loss of the home. Payment shock occurs for a number of reasons; some homeowners don’t understand how their Adjustable Rate Mortgages work or even what their contract interest is.

Benefits of Refinancing Your Adjustable Rate Mortgage

There are a number of benefits from refinancing in addition to locking in your monthly payment amount. If you decide to stick with an Adjustable Rate Mortgage, refinancing could get you a better margin if your credit score has improved. Margin is the amount of markup that’s added your mortgage rate every adjustment cycle; the amount you’ll pay is partially based on your credit score. If you’ve improved your credit rating you could get a lower margin and pay less interest.

Of course the main benefit or refinancing your Adjustable Rate Mortgage with a fixed rate mortgage is having a stable payment amount. When interest rates are on the rise for whatever reason you can expect your mortgage payments to follow. Fixed rate mortgage loans protect you from economic uncertainty and rising mortgage interest rates. If you don’t want to refinance with a fixed rate mortgage you can improve your stability by refinancing with an Adjustable Rate Mortgage with better caps. Caps are safety features that limit how much your payment amount and mortgage rate can rise during any one adjustment and over the lifetime of your mortgage.

Refinancing Can Help You Build Ownership Faster

Refinancing your mortgage with a new loan with a shorter term length allows you to build equity in your home at a much faster rate, meaning that you will pay your mortgage down faster and pay less to your lender in finance payments. The disadvantage of a shorter term length is that your monthly payment will be much higher; however, if your budget can support his payment you can save yourself thousands of dollars in the long run. There are other circumstances where refinancing can raise your payment amount. Borrowing against the equity in your home for instance results in qualifying for a slightly higher mortgage rate and a higher monthly payment. The money you get back can be used for any reason; many homeowners use equity in their homes to consolidate higher interest debts such as credit cards.

Is Mortgage Refinancing Right For You?

There are a number of factors to consider when deciding if mortgage refinancing is right for you depending on your objective for the new loan. Many financial advisors and websites will tell you not to refinance unless your new mortgage rate is at least two percent lower than you’re already paying; however, this so-called “rule of thumb” is bad advance.

Rather than basing your decision to refinance on an arbitrary mortgage percentage rate, it makes more sense to base your decision on how long it takes you to recoup your expenses from refinancing and realize a savings. Here’s why…whenever you take out a mortgage loan you will be required to pay a number of fees and closing costs. If your objective for refinancing is to save money with a lower payment amount you will not realize any savings until you have recouped these expenses.

You can easily calculate how long it will take you to recoup your expenses by dividing the amount of your out of pocket expenses by the amount you will be saving each month on your mortgage payment. This will tell you the number of months you have to realize a savings from the new mortgage. This only works if you are considering refinancing to lower your monthly payment amount. Homeowners refinancing with longer term lengths or borrowing against their homes may never recoup the expenses of refinancing their mortgage loans.

Another factor to consider is the amount of time you plan on keeping your home. If you sell your home before recouping your expenses you will lose money by refinancing. You should not plan on moving prior to the reaching this break-even point for your loan.

Beware Mortgage Broker Fees

Once you’ve decided to go ahead with refinancing your mortgage there are a number of potential pitfalls you’ll need to avoid. These problems include paying unnecessary closing costs, Broker fees and commission based markup of your mortgage interest rate. If you’re not careful a greedy mortgage broker can wipe out any potential savings you stand to realize from refinancing the loan. You can learn more about refinancing your Adjustable Rate Mortgage with a wholesale rate and avoiding unnecessary fees with a free mortgage DVD.

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Cash out mortgage refinancing is the process of borrowing more than you owe on your existing loan and keeping the difference. For many homeowners cash out refinancing is an affordable alternative to a second mortgage or a home equity line of credit.

Suppose for example you owe $100,000 on a $200,000 mortgage and want $25,000 to make repairs to your home. You could refinance your mortgage for $125,000 and the remaining $25,000 will be paid to you at closing. You can use this money for any reason; many homeowners use the money to make repairs, pay for a child’s education, or even consolidate bills. The advantage of cash out mortgage refinancing is that you will qualify for a lower interest rate because your home is secured by only one loan.

When you borrow against your equity using a second mortgage or home equity line of credit your home is secured by multiple loans which represent a greater risk for the lender. The greater risk you pose, the higher your mortgage rate will be and the more expensive your loan becomes.

Keep in mind that cash out refinancing borrows against your equity by replacing your first mortgage. Home equity lines of credit and second mortgages are an additional loan secured by your home just like your mortgage. If you fall behind on the payments for your home equity loan you could lose your home just as quickly as if you fell behind on your mortgage payments.

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Cash out mortgages are no different than conventional loans except that you walk way from closing with a check in hand. The money you borrow comes from your home equity and is added to the outstanding balance of your loan.

Suppose for example you refinance your 8.5% mortgage on a $175,000 balance to a new 6.5% loan. Instead of refinancing the balance of $175,000 you obtain a new mortgage for $200,000 and walk away with $25,000 to spend as you see fit. Sounds like a good deal, right? It can be a good deal; however, there are several things you need to be aware of to avoid making costly mistakes.

One common mistake homeowners make is borrowing too much compared to the appraised value of your home. Mortgage lenders don’t like your mortgage to exceed 80% of your homes value. If you borrow more than this amount the lender could require you to purchase Private Mortgage Insurance (PMI). PMI is expensive and could add hundreds of dollars to your monthly payment. If you borrow more than 80% of your homes value the interest rate you receive will be higher than if you stayed below the 80% threshold.

Mortgage lenders charge more and require Private Mortgage Insurance because the foreclosure rate on cash out mortgages is higher than the default rate on conventional mortgage loans. You can learn more about your cash out mortgage refinancing options, including expensive mistakes like Private Mortgage Insurance that you need to avoid, with our free mortgage video tutorial.

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