While interest rates for home loans are low right now does not mean you will automatically make money when refinancing. In some cases, refinancing may lead to a significant financial benefit, while in other cases it may cost you more than expected. Therefore, before signing any paperwork to refinance your mortgage, you should determine which of these two examples describes your circumstances.
Refinancing is not difficult; it simply means obtaining a new loan in place of your old one. The only difference is that it is an entirely new loan with a different lender. The previous loan will not exist any longer; the new loan will take its place and include different terms, a different interest rate, and a new set of documents similar, yet distinctly different, than those connected to your original mortgage.
This is the area of confusion for many people.
Many advertisements about refinancing include phrases such as, “zero closing costs.” But you should know that just because they say you are paying “zero closing costs” does not mean there are no fees associated with the transaction, rather these charges are simply not disclosed until later in the process. In many instances, closing costs will be included in a higher interest rate for your new mortgage.
Closing costs, such as appraisal fees; local government taxes; lenders’ fees, etc., will always be incurred through the refinancing process. Many people who seem to be getting a great deal may ultimately find out otherwise. If an advertisement appears too good to be true, you may want to do a bit of research and get as much information about the refinancing process before proceeding.
Refinancing is similar to getting a mortgage for the first time. A lender checks your income, reviews your credit, and confirms the value of your property all over again. The biggest difference is this time around, lenders have the benefit of looking at your payment history.
If you’ve made your payments on time for years, that payment history can help you when it comes time to refinance. You are no longer a mystery to them. They may be more willing to work with you.
Three Types of Refinancing Explained in the Wrong Order
Cash-In Refinance (The Unusual One)
This type of refinance doesn’t get a lot of attention. You will have to put money down before you refinance and your final refinance amount will be less than the original amount of your mortgage. Many people refinance this way to build 20% equity, get rid of mortgage insurance, or to recover from an upside down loan.
Rate-and-Term Refinance (The Standard Option)
This is the most popular type of refinancing. The amount of your loan stays the same; however, you can alter the interest rate, the term of the mortgage or possibly both. Many borrowers choose this option primarily to save on interest or change from a variable rate of interest to a fixed rate of interest.
The Cash-Out Refinance is often referred to as the “Controversial fave”.
With the cash-out refinance, a larger loan replaces a smaller loan and gives you back cash equal to the difference between the two loans. Most borrowers use this cash to improve their home, pay off debt or clean up their finances. However, a cash-out refinance typically has a slightly higher interest rate than an ordinary refinance.
Homeowners frequently refinance without reducing their monthly payment. Many people want to shorten their mortgage. By changing from a 30-year mortgage to a 15-year mortgage, a homeowner can significantly reduce their total interest paid. In many instances, the monthly payment actually stays about the same due to current lower interest rates. It is not an exciting tactic, but it can have a tremendous impact.
The Math Moment (Don’t Stress) – One sign that refinancing makes financial sense is if your future savings will exceed the refinance cost. This is the “break-even” point. Break-even compares what you save each year against what you will pay to refinance the loan. For instance, if you save $500 on your monthly payment after refinancing, but it costs you $20,000 to refinance, your break-even point would be 40 months. If your plan is to sell and move in 12 months, you have wasted money on the “great deal” of refinancing.
People are wondering why they are refinancing right now without numbers to back up their decision. When you see historically low mortgage rates, it makes your current mortgage look like a higher-priced mortgage. When there is a drop in rates, people tend to wonder about this spike and lenders see their phones ringing off the hook.
Just because so many people are curious about refinancing, that doesn’t mean that it’s smart to refinance. If you are refinancing a home that you live in (‘owner occupied’), you will usually receive better rates than when refinancing a rental unit (‘non-owner occupied’). This is standard, but it is not cool to tell the lender that your rental property is your primary residence to get a better rate.
By signing the refinancing documents that indicate you have lived in the home for a year, when in fact you don’t plan on living there, you are crossing over into mortgage fraud. Future lenders will be able to determine what your true intent on the mortgage was.
Refinancing can be a smart financial move, a waste of money, or bring you financial stress, based on when, how much math was done, and your honesty about your intentions. Therefore, the best option is not to rush to refinance simply because rates have dropped, but rather to take your time and run the numbers carefully, and meet with someone that is more interested in listening to your goals rather than simply checking a box for you.
Sometimes, the best financial decision is to simply realize that you are already in a good position.
