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Refinance a mortgage at the right time and for right reasons

Author: Jessica Bennet
Community Mentor
Ask Jessica
Posted on: 05th Jun, 2005 10:46pm
Are you stuck with increasing monthly payments and looking for favorable rates and terms on your loan? Or, do you want to consolidate your debts and pay them off faster? All these and more can be done by refinancing your mortgage. If you want to know what refinancing is all about, check out the following topics:
Do it yourself!

What is refinancing?

Refinancing replaces your current mortgage with a new loan that has a more favorable interest rate and terms that you can afford to manage. The new loan is secured on the same property as your current loan. The new loan funds are used to pay down the current mortgage while any remaining money can be used to your best advantage.
Example: Mr. X and Mr. Y both took out a mortgage loan worth $400,000. After 4 years, both of them paid off $200,000. Mr. X then took out another home loan worth $200,000 in order to repay the existing loan balance.
On the other hand, Mr. Y took out another mortgage worth $300,000 in order to repay the unpaid loan balance which is $200,000. Mr. Y could use the remaining balance in order to fulfill other financial obligations.
The first scenario is a simple refinance while the second is that of a "cash-out refinance".

5 Reasons why you should finance

If you're thinking of refinancing your house, check out these 6 reasons why a mortgage refinance might be right for you.
  • You want to save more:
    Your monthly payments will be reduced if you get a lower interest rate or when the term of the loan s extended. However, with an extended term, you will be paying more in interest during the life of the loan.
  • You want to pay down your mortgage quickly:
    You can shorten the length of your mortgage by reducing the term of the loan. Your Monthly payments will go up, but you will be able to save more in interest payments. Moreover, you'll be debt free sooner.
  • You need extra cash to pay off credit cards:
    If you have enough equity in your home, you can refinance and borrow more than the current loan balance. With the extra money, you can pay off high interest debts such as credit card balances or installment loans. This refinance loan may be tax deductible under certain conditions.
  • You wish to consolidate 2 loans into one:
    If there's enough equity (due to high appreciation), you can consolidate a 1st and 2nd mortgage into a single mortgage. The monthly payment on the new loan might be lower than the combined payments on the first loan and the second mortgage.
  • You want to convert an Adjustable Rate Mortgage (ARM) into a Fixed Rate Mortgage (FRM):
    A FRM prevents the lender from ncreasing your monthly interest payments over the life of the loan, unlike with an ARM. This means your monthly payments will remain the same.
  • You want to keep your name in home during divorce:
    In case of divorce, you may want to keep home and at the same time and want your ex-spouse to be clear from mortgage payments. For that you should refinance the loan into a new one in your name only.

When to refinance a mortgage

"Should I refinance my house now?" This is what most people ask when they're looking to reduce their mortgage payments by taking advantage of low rates. To find the answer, check out the mortgage refinance tips below:
  • Build up equity:
    You can refinance when you have built up at least 10% equity in your home (Fannie Mae owned mortgages, require 5% equity). It is possible for you to refinance if you have less than 5% equity, but you may have to pay a certain amount of money in order to make up the difference in equity.
  • Check if mortgage refinance interest rates are low:
    It's better to follow the 2% Rule. The 2% Rule allows you to enjoy the benefits of home refinance if the refinance interest rate is 2% lower than your current loan's interest rate. The savings in interest will help you recoup the costs of the new loan, provided you aren't planning to move soon (the break-even period). However, there are no-cost as well as low-cost refinance loans where the costs of getting the loan are included. However, these loans have comparatively higher rates than loans that do not include the refinance costs and your options are limited when the credit market is experiencing a slump. Learn more about the when to refinance rule of thumb. As always, compare mortgage refinance interest rates offered by different lenders in order to get the best interest rate. This will help you save more over the life of the loan.
  • Pay off any late payments:
    There is no such limit on the number of times you can go for home refinance loans. Most lenders prefer that you have no late payments in the last 12 months before you refinance.
  • Remove negatives and improve your credit score:
    Get your credit report from the bureaus and review it for any negative items (late payments, collections, etc) and inaccurate items. Dispute any inaccurate items and remove them from the report. Pay off as much of your debt as you can. Otherwise, you won't get a low interest rate and may not even qualify for a refinance loan. Of course, there are lenders in the subprime lending market who may offer you a mortgage refinance loan, but it's better to avoid them as they'll charge higher interest rates and fees and could be fraudulent.

When not to refinance

Refinancing is not a good idea if:
  • Your property value has gone down:
    If your property value goes down and you refinance up to 80% of the appraised value, your original mortgage amount may be higher than the amount you borrow. Therefore, the new loan will not be enough to pay down the existing one.
  • You have been paying off the first loan for a long time:
    If you are almost finished paying off a 30 year fixed mortgage, then refinancing is not a good idea. You will lose equity in proportion to the amount you borrow over and above the remaining loan amount.
  • You have used up enough equity:
    Refinancing is not a good idea if you have already reduced the amount of your equity by taking out a 2nd mortgage or a home equity loan. Refinance loans for 100% of the loan are rare, and with the mortgage market currently in a crisis, are hard to find.
  • You have a few years left on the current loan:
    If there are only a few years left on your current loan, then refinancing is not a good idea. Taking out a new loan will only put you deeper into debt just when you were about to become debt free.
Refinancing makes sense for the right reasons and at the right time. You need to decide whether to opt for a simple interest rate adjustment refinance or a refinance that will provide you with extra money. If you'd like to check out what mortgage refinance rates and terms are currently available, request a no-obligation free mortgage refinance quotes from our community lenders and brokers.
Related Readings
Related Forum Discussions

Posted on: 05th Jun, 2005 10:46 pm
Are you burdened with rising monthly payments and seeking better terms and conditions on your mortgage? Or, are you looking to consolidate your unpaid debts and get rid of them faster? All these mortgage scenarios and many more can be accomplished by mortgage refinancing. To get the basic idea on refinancing, go through these topics:
Do it yourself!

What is mortgage refinance?

With mortgage refinancing, you can replace your original mortgage with a new one with better terms and conditions but the new mortgage should be within your affordable limit. The same property that you used as collateral to secure the original mortgage is used to secure the new loan also. The new loan proceeds are utilized to pay off the existing mortgage. In case there is any remaining money after paying down the original mortgage, that amount can be used to meet other financial obligations.

Example: Suppose each of the two borrowers A and B took out mortgage loan worth of $500,000. Again, say after 5 years, both A and B paid down $250,000. So, for both these borrowers, remaining unpaid mortgage amount is $250,000.

Borrower A then took out another loan worth of $250,000, so as to repay the remaining balance on the existing mortgage. This depicts a case of simple refinance.

Borrower B then took out another loan worth of $350,000. Out of this new loan amount, B used $250,000 to pay down the original mortgage. B could use the remaining $100,000 to meet other financial obligations. This describes a case of cash out refinance.

The first scenario is a simple refinance while the second is that of a "cash-out refinance".

5 Reasons that make refinancing sensible

There are some strong reasons which make mortgage refinance a very sensible move. Here we delve upon 5 of those -
  • To reduce monthly payment:
    If the mortgage rate is lowered or if the mortgage term is extended, your monthly payment amount gets reduced. With reduced monthly payment, you can pay off your mortgage with more ease. In case the term of the loan is extended, you have to however pay more in interest during the whole life of the loan.

  • To switch from ARM to FRM:
    Fixed rate mortgage (FRM) offers you the certainty of making fixed payment over the term of the loan. Whereas, in case of adjustable rate mortgage (ARM), the monthly payment amount may rise or fall, depending upon the prevailing mortgage rate. So, in case of ARM, the monthly payment amount is not fixed; rather it is uncertain. If you are looking for certainty in payments, then you can convert your existing ARM to an FRM through mortgage refinance.

  • To repay mortgage faster:
    If you want to pay down the mortgage early, then you can shorten the term of the loan. However, here your monthly payment amount increases. Here, over the term of the loan, you save more in interest payments. You also attain property ownership early.

  • To combine two loans into one:
    If you have adequate equity in your property, you can then consolidate your first mortgage and the second mortgage into a single mortgage. The main advantage of this type of consolidation is that the monthly payment on the single loan is less than the combined payments on the 1st mortgage and the 2nd mortgage.

  • To pay off high interest debts:
    If you have sufficient equity in your home, you can opt for a cash out refinance. You can use the remaining money to pay high interest debts such as credit card bills, car loans, installment loans etc.

What is the best time to refinance?

You may not always be eligible for refinancing or the situation may not always be conducive for refinancing. You have to time your move correctly so as to reap its benefits. You need to check out these crucial things carefully before applying for mortgage refinancing -

  • If you have built up equity:
    You may be eligible for refinancing when you have built up equity of at least 10% in your home. However, for mortgages owned by Fannie Mae, the equity requirement is 5%. It is possible to get the refinance approval even with less than 5% equity, but in that case you may have to pay a certain sum of money to compensate for the deficiency in equity.

  • If the refinance rate is sufficiently low:
    If the current mortgage rate is sufficiently lower than the rate on the original mortgage, then it may be wise to opt for refinancing. Here, you need to follow the 2% Rule. As per the 2% Rule, refinancing is beneficial for you in case the refinance rate is 2% lower than the rate on the original loan. Here, the savings accrued from low rate outweigh the costs of the new loan after a certain period of time, which is called the break-even period. To get benefits of refinance, you have to stay in the house at least till the break-even period.

  • If you have removed negative items and paid off debts:
    Before plunging into refinancing, obtain your credit report from the credit bureaus and review it carefully. If you find some negative items such as collections or late payments, dispute those items immediately and get those items removed from your report. Prior to refinancing, pay down as much debts as possible. All these will work in your favor in getting the refinance approval.

  • If you have no late payments in past 1 year:
    If you have history of late payments in the past 1 year, then your refinance appeal may be rejected. So, before refinancing, make sure you don't have any late payments in the past 1 year.

When refinancing is not a good idea?

Despite the fact that refinance has several benefits, it is not always a good idea to go for mortgage refinancing. There are some cases when your refinance appeal is rejected by the lender or it may not fetch the desired returns. Here are some cases when refinancing is not a good idea at all-

  • If the property value has declined sharply:
    If the value of your property has declined appreciably, the remaining balance on your original loan may be higher than the refinance loan amount. In other words, with the new loan proceeds, you won't be able to pay down the original mortgage loan.

  • If you have already used up your equity:
    Your equity is the key to get approved for refinancing. If you have already used up your equity by taking out a home equity loan (HEL) or a home equity line of credit (HELOC), then going for refinancing would not be a good idea.

  • If you have only a few years left on the existing loan:
    It does not make good sense to go for refinancing if you have only a few years left on your existing loan. It is not rational to refinance the loan which you have almost paid off. If you have almost paid down a 30-year fixed rate mortgage, then it is unwise to opt for refinancing. After all, refinancing is just like taking out a new loan and all the costs associated with taking out a fresh loan are applicable here too.
If you have the right reasons and if the time is right, then you can surely seek for mortgage refinance. However, before making the final decision, do the necessary research, take quotes from different lenders, make a comparative analysis and choose your lender.

Related Readings
Related Forum Discussions

meta title: 
Refinance a mortgage at the right time and for right reasons.
You can try out the refinance calculators provided by this community. I hope you will be able to find out if refinancing is a good choice by using the calculators.
Posted on: 10th Aug, 2007 06:48 pm
I have a 30 yr fxd mtg at 8.25% for $300,000 and I want to refinance it. But it has a prepayment penalty which will be $5000. I consulted one broker and he offered that I take a interim 30 yr with rate of 8.5% for an amount of $305,000 to include an extra $5000 towards coverage of prepayment penalty. It would cost me $2600 from my own funds and reduce the gain to $2400. Then I will again refinance after three months for a better rate. Payment on this interim loan would be $2345, which would have been $2100 if I had directly taken the final loan at 7.5% and 0 points. I would be losing $245/month for three months and it would reduce my gain to $1665. But still I would gain in this transaction. Should I follow what broker is suggesting?
Posted on: 21st Aug, 2007 04:13 pm
Hi Naylor,

Broker is making you feel that you would be able to avoid paying for the prepayment penalty which is not so and you won't gain from taking an interim loan.

What you would be doing is merely borrow an amount which is equal to the PP. It will not be costing you anything out of pocket to borrow but you will be paying it back along with interest on it.

Suppose you refinance for the rate which will be offered on the final loan at 7.5% without taking the interim loan for an amount equal to the balance on the existing mortgage ($300,000). It would then cost you a prepayment penalty of $5000. So the total cost for the new mortgage would be $305,000.

In case where you take an interim loan, you pay $2600 from pocket, in addition a total of $735 in 3 months as extra monthly payments & get a loan for $305,000. So, total cost comes out to be $308,335.

By taking the interim loan you are not able to avoid paying for prepayment penalty. So whatever costs are associated with it, you are going to pay for them from your pocket.

These interim refinance mortgages which are explained to borrowers as a way of avoiding prepayment penalty are scams. These scams are used against borrowers who are more interested in how much they are paying out of pocket or receiving today & what their monthly payments are.

Posted on: 21st Aug, 2007 04:38 pm
If I refinance my mortgage after 5 years which is a 8% mortgage for a 30 yr term, without starting the 30 yr amortization period again and to pay off the loan in the period that was for the original loan (meaning after 5 years I want to pay off the new loan in the rest 25 years even if the loan term would be of 30 years). As per my understanding one way is to borrow an amount equaling what was the original balance and then immediately prepay a sum equal to difference between what was the original & current balance. Is this is correct method or a good method? Please help me out.
Posted on: 24th Aug, 2007 06:22 pm
Hi Baldacci,

Welcome to Mortgagefit discussion board.

There are other ways by which it can be accomplished.

We assume that you have a $250,000 frm of 30 yrs @8%. The mortgage payments are $1834.42. If you do not make any extra payments, five yrs later balance on your mortgage will be $237,674. At that time suppose you have the opportunity to refinance for 7% with a new 30 yr mtg, but you are looking to pay this new loan off in 25 yrs instead of 30 yrs., then some options you have apart from what you have learned are:

Shorten the term:

You may make the term short for the new loan to be of 25 yrs instead of 30. Your payments will be $1679.84 instead of $1581.25, as increased payment schedule because of the shortening of the loan term. But even then the payments would be less than your current payments. Some lenders offering 30 yr term loans would allow 25 yr term at the same rate applicable for a 30 yr mortgage.

But negative to this type of approach is that most often the lender will not customize the loan as per requirement of the borrower. Like someone with a 30 yr mortgage which is 3.5 yrs old, the new loan can't be for a 26.5 term.

To borrow what was the original balance & prepay:

This option is what you have read about. In this method, you will borrow original loan amount, $250,000 for a term of 30 yrs and then prepay $12,326, which will result in shortening of your loan to a term of 25 yrs & 8 months.

This method has also some drawbacks. As you will be borrowing than what is the current balance on the loan, it will be considered as an cash out refinance and some lenders would price is higher. Additionally refinance costs would be higher because of the higher loan amount.

The last option - add to the payment:

A better alternate method is to increase the payments by the exact amount which will be required to amortize the loan over the period you want (25 yrs.). For the example that I mentioned, it would be $1679.84 payments instead of the normal payment of $1581.25. Using this method you can pay off the loan exactly in the time duration as you require.

Do let me know if you have any other questions.

Posted on: 24th Aug, 2007 06:52 pm
Will refinancing go against my credit report or credit?
Posted on: 26th Aug, 2007 08:08 am
Hi Momkim,

Welcome to the forum.

If you go for refinancing, it will not affect your score negatively. Refinance is not listed as a negative item on your credit report. Only if you default on a loan, file bankruptcy or foreclosure, then it will be reflected on your credit report.
Posted on: 27th Aug, 2007 12:51 am
Suppose we refinanced six months ago into a frm of 30 yr term of say 6.125. Now if loan officer is tells that it is possible to get even lower rate of say 5.75, what should be correct for me? I would have already made payments for five months, would it be right to give that up now & refinance my mortgage with this new rate?
Posted on: 01st Sep, 2007 06:14 pm
As you would be getting lower rate by refinancing, it would be beneficial to accept this offer. But you need calculate & compare how much would be the refinance costs with the savings you would be able to make from the reduction in rate. Also check if there is a prepayment penalty clause in your mortgage and how much it would come to. Refinance costs plus prepayment penalty amount compared to savings gained from reduction in payments because of the rate reduction, this is what you have to look at before making the decision.
Posted on: 01st Sep, 2007 06:40 pm
I am staying in my current home for 5 years and I'm paying for a 30 year fixed rate loan. I will be moving out and thereby selling in the next 3 years. So do you think it is feasible to refinance with a 3/1 year ARM now?
Posted on: 15th Oct, 2007 02:10 am
Welcome Timberly,

If you can manage variable payments and a higher rate of interest (because rates on ARMs have gone up), then only you should go for the 3/1ARM. But hey, just a moment, you said you're moving out within the next 3 years right? Then I don't think it is the right decision to switch to an ARM now.
Posted on: 15th Oct, 2007 02:15 am

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Mortgage Specialist
Colorado Home Loans
Posted on: 18th Oct, 2007 12:30 pm
I am looking to refinance my mortgage. I have been divorced recently and got the house in settlement. i plan on doing some repair work in the house that is yet to be finished. But I could also pay off the house with the money I received from the settlement. But will that be helpful for me? The other option is to refinance the house and get extra cash for the repairs. The current loan is that of a refinance at 7% rate of interest. Any advice would be appreciated.
Posted on: 26th Oct, 2007 11:54 pm
Hi Jason_Turner,

If you can pay off your mortgage and complete your repair works with the money you have received from the settlement, then it is better to do that. Otherwise you can go for refinance. But in that case, do you have enough equity to support your refinance? You have said that your current loan is that of a refinance at 7% rate of interest. So can you get lower interest rate? If so you can go for it.

Posted on: 27th Oct, 2007 12:20 am
Hi Larry,

If Jason has enough money to pay off the mortgage and repair work in the house; and also get lower rate in the refinance loan, then which one is better to choose?
Posted on: 27th Oct, 2007 01:58 am
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