Interest rates are constantly in the news: they’re rising, they’re falling, they’re flat — whatever they’re doing, they keep the thought of refinancing in the forefront of the minds of many homeowners. These folks wonder if they should refinance now, or if they’d be better off to wait a little while longer. Choosing to refinance is a very personal decision and one that shouldn’t be made blindly. We’ve put together this handy guide to refinancing your mortgage to help you better understand the ins and outs of this complicated process.
Refinancing is About More Than Just Saving Money
Perhaps the most common reason people give for refinancing their mortgages is to save money — either on their monthly payment or on their long-term mortgage interest and fees. However, there are a number of other good reasons to refinance, such as:
Eliminating a troublesome mortgage. Any homeowner with an ARM or mortgage with a balloon can tell you how problematic these products can be over the long-term. If you plan to be in your home very long, the ARM will adjust or the balloon will come due and you’ll have to scramble for extra cash. Moving these temporary loan products into a more permanent fixed-rate loan is always a good idea if you plan to stay in your home for the long-term.
Changing the parties on your deed. In 26 states, Tenancy by the Entirety is the most common form of ownership for married couples (and in states that allow it, registered same-sex unions). If you live in an Entireties State, you don’t have to worry about adding your spouse to the deed of any real estate you owned prior to the marriage, they will automatically have ownership as your spouse.
However, in the other 24 states, if you want your spouse to inherit your property, they’ll need to be given some kind of formal ownership. For properties that are mortgaged, most mortgage companies will want the new spouse (or any other owner you’d like to add for whatever reason) to also sign onto the mortgage. Since you can’t normally change mortgage terms after closing, adding another person to your deed usually requires a refinance.
Shortening your mortgage term. When rates are falling fast, it’s possible to shorten your mortgage term considerably by moving from a higher interest 30-year mortgage to a low interest 15-year mortgage. If your payment will stay very close to the same on a 15-year mortgage as it was on your 30-year mortgage, there’s absolutely no reason to not take advantage of dramatically falling rates.
Now, as for saving money by refinancing — if you’re going to refinance a perfectly good mortgage for this reason, you need to really think it through. Consider how long you plan to continue to live in your home, how much equity you’ve already built and the closing costs that you’ll have to pay to do this financial hokey pokey. More often than not, a good mortgage will not gain any ground from refinancing, but once in a while the stars align just right.
If you’re shopping for a straight refinance, wait until you’ve managed to free at least 20 percent of your home’s equity (25 percent would be even better) — at that point you can shed any mortgage insurance that may remain from an FHA loan, which will make a pretty big difference in your payments. For example, on a 95 percent loan to value, 30-year fixed rate FHA mortgage with a 4.25 percent interest rate made on a home that originally cost $150,000, you could save as much as $130 in the first month (remember that this amount would have decreased as your mortgage balance decreased).
It’ll take a little over eight years for the mortgage above to reach a point where a profitable refinance is possible. If your family is growing or shrinking, you’re considering a move or any other large life event is looming, you’re more likely to sell before you’ll realize enough savings to cover the closing costs you paid to refinance. I’ll repeat myself for emphasis here — if you’ve got a good mortgage, the mortgage insurance (PMI) can be cancelled at your 80 percent equity point and your rate is below 5 percent, you’re not going to do yourself any favors with a straight refinance.
Cash Out Refinances are Different Beasts
I know I just said not to refinance if you’ve got a good mortgage — but there is an exception to this hard and fast rule. When you’ve managed to establish some equity, your bank may allow you to refinance up to a certain amount of your home’s value. YOUR PRIMARY HOME IS NOT A PIGGY BANK, but if you’re seriously considering major home improvements or are looking to use that equity to purchase a second home or rental property, you may get a better rate on the cash you need by borrowing against your current home.
These loans are heavily regulated and have strict requirements today because so many people decided that they’d rather take a vacation with those funds or spend them on something shiny and useless. Cash-outs were a big thing prior to the crash — and no one considered how much extra they’d pay for that money because they assumed their home’s equity would catch up to the amount they had borrowed. We all saw how that ended.
If you’ve got the option to use a HELOC as a second mortgage, go that way rather than cash out, you’ll save a ton on mortgage insurance (PMI start again after you re-mortgage above 80 percent of your equity). If you must borrow the funds, just make sure you’re using them to increase the value of your home — at least then you can cancel your mortgage insurance sooner rather than later with a re-appraisal.
What About Zero-Cost, Streamline Refis and HARP?
When you venture away from the standard refinance products, you’ll find yourself in the land where Zero-Cost Refis, Streamline Refis and HARP live. These products aren’t necessarily bad or good, but each has a purpose and drawbacks. I’ll walk you through each briefly:
Zero-Cost Refinance. A zero-cost or zero-closing cost refinance is a hideously misleading loan product that works as a marketing hook. Trust me, you’re not paying nothing for that refinance — what you’re doing is not laying any cash out at closing. Instead, you’ll pay a much higher interest rate and other fees that are added to your loan balance, so watch out for these. If you’ve got enough equity in your home, a traditional lender may allow you to roll your closing costs into the new loan — essentially doing the same thing as the zero-cost crowd, but with no strings attached and a much better rate.
Streamline Refinance. Streamline refinances are actually pretty neat products, but consumers have confused them for zero-cost refinances and often end up surprised at what they have to pay at closing. These aren’t zero-cost refis, instead they’re no hassle refinances — your current bank takes your information from your original loan and makes the new one based on it. They’re handy if you need to shed an ARM or want to reduce your mortgage’s interest rate, but are typically limited to FHA or USDA loans and can only yield a new loan of the same type.
Home Affordable Refinance Program (HARP). HARP was designed as a way of saving underwater mortgages during the years of fall-out from the real estate bubble. It only applies to loans made before May 31, 2009 and will cease to be on December 31, 2015 — but for homeowners who qualify, it’s a great program that will provide very low mortgage rates and other incentives to help accelerate a return to positive equity.
These less common refinance options certainly have their places in the market, but they’re not a quick fix to your mortgage woes — even with a program like HARP, you have to be able to show a willingness to make your payments and the ability to do so indefinitely. Not everybody is going to qualify.
Important Information On Your Right of Rescission
Refinances are different from purchase mortgages in a few ways, but the most important is the Right of Rescission. Essentially, it allows you to change your mind about your refinance up to three days after your new mortgage has closed. You’ll have to return any funds you cashed out, but it’s an important legal footnote to keep in mind if you get to closing and something seems fishy about your refinance. Even if you’re pressured into signing at the closing table, you can request your new loan be cancelled as soon as you leave.
Check the paperwork that you brought home from closing. Within it should be a sheet that explains what you must do to rescind your loan and who to contact. Typically, lenders require a written notice mailed or faxed within the three-day window specified on your paperwork. It may state that you have three business days to initiate your complaint, but Saturdays are counted as business days, so don’t mess around if there’s a problem with your loan.
If you didn’t get this document at closing, call the closing company right away to see if they have it in their information — oversights are always possible. Just because you didn’t get a notice doesn’t mean you don’t have the right to rescind, it only means you didn’t get the sheet outlining the information.
Hints for Getting the Most Out of Your Refinance
Well, you’ve read this far — if you’re sure you still want to refinance, you’d do well to get as much out of your new loan as possible. A better rate and less mortgage insurance are just a few of the benefits you’ll reap by maximizing your (and your home’s) suitability for a refinance. These are just a few things you should do before you begin shopping for a new loan:
Check your credit score. FICO is a fickle mistress, she can be high one day and low the next. Know your credit score before you talk to the first lender on your list.
Pay down your debts. Your credit score and suitability for a loan are both based in part on your percentage of debt when weighed against your credit lines and income. If you’ve only used about 20 percent of your credit card’s available line and have already paid off as many debts as you can, you’re going to look much better than if your credit lines scream that you’re completely tapped out.
Fix up your house. They say that appraisers don’t care if your house is clean or dirty, but I can tell you that’s a big, fat lie — they’re still human and prone to making assumptions. Put a little elbow grease into it, class up the color scheme and take out anything that’s making the house feel dark, dated or disgusting.
I really mean it — clean your house to a hospital shine, put in some artwork, give it some new life. An appraiser sees enough homes in a day that they key into signs of a quality home that’s well-loved — cleanliness, lots of light and a generally pleasant atmosphere are musts before they come. Don’t forget the yard and front of the house, either — they’re your first chance to make a good impression.
The Bottom Line: Refinances Aren’t For Everybody
Every time mortgage rates so much as shudder or the Federal Reserve Board sneezes, you’ll start hearing about how you have to refinance right now — because rates are going up, or they’re going down. Don’t fall for the flash — refinances aren’t for everybody. If you have a specific need for a refinance, by all means take out a new loan, but do so knowing that you’re going to stay in your home a while. In some states you lose extra foreclosure protections by refinancing, please proceed with caution.