Refinancing Home Mortgage Loans

Refinancing is usually very popular with homeowners when interest rates drop, as they may be able to reduce the monthly mortgage payments, freeing up spendable income. The main problem with refinancing a mortgage is that most lenders treat it as a new loan and generally require closing costs equal to 3-5% of the loan amount. These closing costs must be calculated before determining the wisdom of refinancing. Generally, there should be a 2% difference between the existing interest rate and the new rate to make the refinance to lower rates worthwhile. In practice, the most important consideration is how long will the homeowner retain the refinanced mortgage, so the refinance charges can be recovered. But this is typically the question many homeowners cannot answer.

Another important consideration in refinancing is the term of the new mortgage. It may not be wise to refinance to longer terms as the additional interest paid will eat up any savings in payments over the long term. If you refinance to shorter terms than the existing years remaining on the mortgage, your payments will not be reduced as much monthly, but you would eliminate thousands more in interest and pay your loan off much sooner. If for example, you have a 30 year mortgage but four years have already been paid, you should refinance to a 25 year term, rather than to another 30 year, as you would lose the four years already paid. The 25 year loan also builds equity faster, as more money is going to principal. People who know they will live in the house long enough to recover the refinancing costs, but not long enough to pay off the mortgage should consider refinancing to longer terms. Also, people under financial pressures would rather save more money now with the longer terms, but they are usually giving up money over the long run. Perhaps the best advice of all is to refinance to a shorter term mortgage with about the same monthly payments. That is, instead of refinancing a 30 year mortgage to another 30 year term and saving $200 per month, a homeowner would be better of to refinance to a 15 year term with the same payments and forego the $200 monthly saving. This would eliminate approximately 2/3 of the interest associated with a 30 year loan, build equity five times faster and retire the loan in 15 years instead of 30!

Another important consideration when deciding whether to refinance is what type of mortgage will you obtain to replace the existing mortgage. In the event the existing loan is a VA or FHA loan, check into a "streamlined refinance". VA and FHA allow lenders to skip some of the qualification rules and closing costs if the existing loan meets certain requirements. Streamlined refinances do not have to be made through the original lender, so check with other VA/FHA lenders if yours does not participate. Some conventional mortgages are also eligible for streamlined refinancing, but generally must have at least 25% equity to value to be eligible.

Most people traditionally refinance to fixed rate mortgages as opposed to adjustable rate mortgages to lock in the lower interest rates for the balance of the term. But many new mortgage instruments offer a tempting alternative that may give the homeowner the best of both. For example, the 5/25 and 7/23 ARM programs carry initial rates lower than fixed rates but will not adjust for 5 or 7 years. The advantage is interest rates as much as ½% lower than fixed rate mortgages for the first 5-7 years. The down side, the mortgage adjusts to a market rate after the 5-7 year initial period which may carry substantially higher payments at that point. Another almost unknown option is to pay the lender cash for interest rate buydowns to get the rate even lower than market rates. Most lenders will allow the borrower to pay 5-6 points on the loan as a buydown, which would lower the interest rate approximately 1% for the entire loan term. The $5000-6000 dollars paid to buy the rate down is considered pre-paid interest and is tax deductible! This buydown also guarantees a fixed rate 1% below what everyone else is getting.

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