When you refinance, you pay off your current mortgage and replace it with a new one. Refinancing is a good idea only if the benefits are greater than the costs. If you answer yes to one or more of the following questions, it might be time to refinance your mortgage.
- Are today's interest rates significantly lower than the rate you have on your mortgage?
- Do you have a higher credit score now than when you applied for your mortgage?
- Do you have multiple mortgages that you want to roll into one?
- Do you have an adjustable rate mortgage (ARM) that you want to convert to a fixed rate?
- Do you want to lower your monthly mortgage payment?
- Do you need cash to pay for a special purchase or to pay off debt?
Things to consider before refinancing
- What is your mortgage interest rate? It makes sense to investigate refinancing if the interest rate on your mortgage is at least 2 percentage points higher than the current market rate.
- How many years have you had your mortgage? For the first few years of a mortgage loan, you pay mostly interest on the debt. Only a small portion of each monthly payment is used to pay down the principal. Toward the end of your repayment term, most of your monthly payment goes to principal and only a small portion is used to pay interest on the debt. When you refinance, you start the amortization process all over again. Make sure you consider the length of time it will take to build equity after the refinance.
- Does your mortgage have a prepayment penalty? If so, make sure the benefits of refinancing are greater than the penalty amount.
- What does your credit look like? The interest rate that you qualify for is directly related to your credit score. Before you apply for refinancing, make sure your score is as high as it can possibly be. Go to www.annualcreditreport.com to get a copy of your credit report. Learn how to fix credit report errors and how to improve your credit score. To get your credit score contact the three agencies listed below. Each collects and reports information in slightly different ways, so make sure you check your credit score with all three.
- Equifax: (800) 685-1111
- Experian: (888) 397-3742
- TransUnion: (800) 916-8800
The Price Tag of Mortgage Refinancing
You can expect to pay between 3% and 6% of the principle amount of your mortgage in closing costs. You can either roll the closing costs into the mortgage amount or pay for them with cash. If possible, pay the closing costs up front to avoid paying interest on them for the life of the loan.
Mortgage Refinancing Options
To learn more about refinancing and evaluate whether or not it makes financial sense for you, start by contacting your current lender. He or she might be able to offer you discounted fees and closing costs. Contact five or six other mortgage lenders to make sure you are getting the best offer. The following is a review of refinancing options.
- Fixed rate mortgages
Interest rates and monthly payments are set when you apply for the mortgage and remain the same for the entire life of the loan.
- Adjustable rate mortgages
There is a low introductory interest rate that is fixed for certain period of time, usually three to ten years. After the introductory period is over, the rate can adjust periodically based on a market index. If there is an adjustment cap, the interest rate can't increase more than the cap in any one adjustment period. If there is an interest rate ceiling, the interest rate can't go over the ceiling during the life of the loan.
- Renovation loans
The amount you are able to borrow is based on the projected value of your home after the renovations are complete. This type of loan provides a good alternative to a second mortgage. You can include your original mortgage in the refinance and get extra cash to fund your improvement project.
- Cash out refinance
Borrow more than what you owe on your home and receive the difference in a cash payment.
- Streamline Your FHA Mortgage
Your interest rate or repayment period changes, but your credit and debt-to-income ratio are not evaluated as part of the approval process. In order to qualify, your resulting monthly payment must be lower than your current payment, and it must be an FHA or VA loan.
- Making Home Affordable
This is a program designed for people holding a Fannie Mae or Freddie Mac mortgage who owe more than their home is worth. To be eligible, you must be current on your mortgage payments. Click here for more program information.