|The decision to refinance is largely a financial management decision based upon desired results and outcomes, not necessarily interest rates. You may have heard: "only refinance if you can reduce your interest rate by 2% or more." This was a pretty good rule of thumb when the average loan balances were around $60,000-70,000 (circa 1985).
Changes in home appreciation, larger loan amounts, changes in real estate tax treatment, and superior mortgage programs have made the "2% rule" obsolete. In many cases only a ½ % difference or less (sometimes 0%) is very beneficial depending on your objectives.
Refinance objectives fall into two major categories: rate-term refinances or cash-out refinances.Rate-Term Refinances
Rate term refinance is a new loan to payoff the existing first mortgage and any subordinate liens if they were used in the original purchase of the home. Closing costs and prepaids may be rolled into the new mortgage amount usually up to a maximum loan-to-value (LTV) of 90%. Certain loans owned by Fannie Mae and Freddie Mac may be eligible to refinance at higher loan to values, please contact one of our loan officers for more detailed information.
Typically, refinance borrowers roll closing costs and prepaid items into the new loan amount. The escrow items rolled into the new refinance loan will be about the same amount that will be refunded from the pay-off of the old mortgage. Effectively the new and old escrow accounts net each other out.
If you only owe on your current mortgage and other low-balance short-term debt you may just want to refinance for the sole purpose of reducing your interest rate and/or decreasing the term on the loan, a rate-term refinance.
Also consider refinancing if you have a fairly large equity line that will not be paid-off in a few years. The weighted average interest rate between the equity line and the first mortgage may be such that substantial savings can be realized refinancing even if the new rate is slightly higher than your existing first mortgage rate.Cash-Out Refinances
A cash-out refinance allows the borrower to pay off the first mortgage and any other liens, include closing costs and prepaids plus receive cash back at closing. There are usually no restrictions as to the use of the cash back.
Cash-out refinances were traditionally limited to 75% of the appraised value of the home. There are now programs that allow the new mortgage amount to go up to 80% of the value. However, as the LTV increases over 60% so will the interest rate.Is the time right?
To determine if refinancing will be worthwhile, divide the closing costs on the new loan (exclusive of prepaids and escrows) by your proposed monthly savings including equity lines and second mortgages. This will give you the number of months required to re-coup your closing costs. (Even though you can roll closing costs into the new loan with little or no out-of-pocket expense, you should make the comparison). After this break-even point, you will be saving the reduced amount every month.
The best combination of lower rate versus lower closing cost is largely a matter of how long you will have the proposed mortgage outstanding (i.e. when you will be moving or how soon you believe you may refinance again). The longer you believe you will have your proposed mortgage, the more advantageous buying down the rate may be. The shorter the time you have the proposed mortgage, the less advantageous buying the rate down becomes. With shorter periods, you should strive to minimize closing costs, even if means a slightly higher interest rate.
If you are considering reducing the term on your loan i.e. moving from a 30 year loan to a 15 year loan, consider the amount of closing costs but realize that your payment may actually go up even with a lower interest rate. However, you will save the amount of the closing costs many times over in reduced interest costs during the shorter life of the loan.Other refinance considerations
In general, it is best to borrow money to purchase appreciating assets and pay cash to purchase depreciating assets. Many homeowners have reversed this premise: spending more cash on their mortgage—paying extra each month, biweekly payments, 13th annual payment while borrowing to pay for automobiles, family vacations, college tuition, wedding expenses, etc.
Basically, there is good debt (low tax deductible interest leveraged against an appreciating asset like your house) and bad debt (high non-deductible interest leveraged against a depreciating asset). If you have debt (as is the case with most homeowners), mortgage debt is the best debt of all.
You can borrow money more cheaply than any Fortune 500 corporation! The low tax deductible rates, long amortization periods and appreciating value of your home create a "buying efficiency" that’s unmatched in our marketplace. The best use of your creditworthiness and monthly cash-flow may be to maintain or increase outstanding mortgage debt, eliminate all consumer debt, preserve and increase liquid, current value dollars exposed to compounding rates of return.
Depending on your average rate of return (over the long haul), the fastest way to pay-off your mortgage may be to owe as much as you can on your home and invest the forgone equity into higher returning assets. Of course you must also consider the tax implications of liquidating these assets if you decide to pay-off the mortgage as well as eliminating the mortgage interest deduction.
Food for thought...
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