When not to refinance
On the other hand, a little number crunching may indicate that refinancing a mortgage is not right for you at this time.
If you don't plan to be in the house for very long, you should probably stay in your current mortgage. Here, the number of months it takes to recoup closing costs becomes the more important calculation done by the refinancing calculator. (Bing: What are interest rates on 15-year mortgages right now?)
If you owe more on the house than it's currently worth — you're underwater, in the lingo of the mortgage business — you might be able to refinance under the Home Affordable Refinance Program, or HARP. This refi program is for homeowners who are current on their mortgages.
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Type of refinancing
The two major types of refinances are cash-out refinancing and standard "plain vanilla" refinancing, where you are just refinancing the existing mortgage balance.
In a cash-out refinancing, you take out a new mortgage on the same property in which the amount borrowed is greater than the amount of the previous mortgage. The difference is taken out in cash.
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A cash-out refinance will typically have a slightly higher interest rate than a plain vanilla refinancing because the lender has more money at risk. Cash-out refinances often are used to pay down debt, but this type of mortgage has both pros and cons.
For example, imagine that you use a cash-out refinance to pay off credit card debt. On the pro side, you're reducing the interest rate on the credit card debt and freeing up lines of credit on your credit cards.
On the con side, you may pay thousands more in interest expense because you're taking 30 years to pay off the balance you transferred from your credit card to your mortgage. You also run the risk of running the balances back up on your credit cards and not being able to make the payments.
However, the biggest risk in this scenario is in converting an unsecured debt into a secured debt. If you can't afford your credit card payments, you get nasty calls from debt collectors, a black mark on your credit report and a lower credit score.
Miss a few mortgage payments and you can lose your home to foreclosure.
On the other hand, a plain vanilla refinancing is intended to replace your existing mortgage with a new one at a lower rate. There's no cash out, unless it's to cover closing costs.
One advantage of a plain-vanilla refinancing is that it usually offers a slightly lower interest rate than a cash-out refinancing. Another major plus of this type of refinancing is that you aren't significantly increasing your outstanding mortgage debt.
That said, cash-out refinancing a mortgage can be more appropriate to accomplishing certain goals, such as paying off debt.
While a refinance can help you harvest more cash, it's important to watch out for costs that eat into those savings.
First, recognize that there's no such thing as a free lunch, and there's no such thing as a "no closing cost" mortgage. The originating lender will get paid for its efforts; it's just a matter of how they get paid. Closing costs can be paid in origination points, a higher interest rate or a higher loan amount.
Points come in two flavors, discount and origination. Discount points allow the borrower to prepay interest expense upfront and buy down the nominal or stated rate on the mortgage loan. The points paid are, however, considered in calculating the annual percentage rate, or APR, on the loan.
Don't forget about other expenses, such as private mortgage insurance. If your loan-to-value ratio is more than 80% of the appraised value of the home, the first mortgage lender will want you to pay for PMI. That adds to the cost of the refinancing.
Keep in mind that avoiding junk fees can keep down your closing costs and improve the return when refinancing a mortgage.
Do it once: Ideally, you only want to refinance once on your current mortgage. While no one can tell you with certainty where interest rates are going, you can keep your finger on the pulse of where interest rates are headed by researching and staying current about market trends.
Know where you stand: Before you refinance, know where you stand with your current mortgage — including the loan terms and interest rate, as well as relevant factors such as your credit score and whether or not the loan has a prepayment penalty.
Consider a mortgage broker: A mortgage broker is truly needed if you have a "story loan" — in other words, you have to sell your story to the lender in order to get approved for the loan.
Tidy up credit: Getting your credit history and credit score in the best possible shape will help you get a better mortgage rate. Review your credit reports and get copies of your credit scores as well. You're entitled to at least one free credit report each year from the credit bureaus, but you'll have to pay to get a copy of your credit scores.
Most importantly, try to join a Credit Union and get your mortgage through a Credit Union. Credit Unions are the only safe place for citizens to put their money, keep their money, and get loans.
I plan on on refinancing by covering closing costs and points with the built up equity. I owe $100k at 6% now. How low can I go?