When you engage in a refinance of your mortgage loan you are agreeing to replace your existing loan with a new one. This means new terms, rates, and payments. Typically those terms and rates should be favorable to you, saving you money and justifying the refinance process.
One of the first items you’ll want to review is the terms of your current mortgage. You should have an understanding of what you are paying each month, your current interest rate, how long you have had your current mortgage loan, how much you will pay over the life of the loan, and if any pre-payment penalties apply. This information will help you make a fair comparison against new rate quotes and programs that are being offered today and will clearly show if it makes sound financial sense for you to consider refinancing.
For example, here’s a basic look at what the difference between paying a 6% interest rate and a 3% interest rate could mean to you on a 30-year loan of $300,000:
Of course, there are many other factors you’ll need to take into consideration. You’ll want to determine the amount of equity you have in your home, as that will help narrow down what type of refinance loan you may qualify for, and if you’ll need to pay mortgage insurance. You may be required to get an appraisal, which is simply a professional estimate of your home’s current worth. Understanding your home’s value today is critical in helping to determine the best financing options available to you.
As with any mortgage loan, a refinance will also require completing paperwork, including a loan application that will help determine your eligibility. Depending on the type of product you choose, your loan approval will be based on a variety of personal financial factors. The good news is that there are a variety of programs available to meet the needs of different types of borrowers and situations, including traditional refinances, (where credit scores, current debt, and loan amounts will weigh greatly on approvals), as well as government programs designed to help homeowners who may not have ideal credit. Under the Making Homes Affordable Act, there are even several programs that can assist those underwater on their mortgage.
Also keep in mind that you will be required to pay closing costs on your new loan, which vary depending on your lender and location. You will need to have a good understanding of what these costs will be and factor them in when determining if a refinance is right for you. You should examine your break-even point as well, which will clearly show you the amount of time it will take you to recoup the closing costs that you will incur with a refinance. For a clearer picture of this, let’s look at an example:
You have decided to refinance and will be paying closing costs of $5000. The new loan will save $200 a month. The breakdown below shows you that it would take just over two years, (25 months to be exact) to recoup your closing costs.
- Total closing costs: $5000
- Amount saved per month: $200
- Amount saved per year: $200 x 12 months= $2400 per year
- Amount saved in two years: $ 200 x 48 months= $4800 in two years
- Amount saved in 25 months to fully recover closing costs: $5000 in 25 months.
Depending on the length of time you plan to stay in your home, this may or may not make sense.
One final consideration to evaluate is tax implications. You should examine the tax deduction you’ll receive with the new loan versus the old. Are the deductions larger or smaller and how significant are the differences? The ability to write off mortgage interest is a significant deduction for many households and you’ll want to ensure you are not losing money by refinancing your loan. It’s best to consult with your tax adviser to review this before making a move.