As Property Values Increase, What Are My Options For Refinancing?
As property values across the country continue to increase, tapping into home equity is becoming a viable option for most homeowners. There’s no question that rising home values and favorable interest rates generally create good conditions for refinancing. For most homeowners, the chief concerns are when does it make sense to refinance, and what options are available?
When you refinance your mortgage, you get a new mortgage to replace the current one. This can be done for a variety of reasons: to get better terms for your mortgage, to acquire funds for a major purchase, or to obtain a line of credit that you otherwise might not be able to get. For different objectives, there are different options to consider.
Most people refinance to reduce their monthly payment, but some refinance from a 30-year to a 15-year mortgage term if they want to knock out their mortgage debt more quickly. Refinancing isn’t the same as a second mortgage. Where a second mortgage gives you money from your home equity, refinancing gives you an entirely new mortgage, ideally with more favorable terms.
There are always associated costs when it comes to refinancing, so you need to make sure it’s worth your while. When you buy a home, you have to pay certain closing costs to complete the sale. The same is true when you refinance, because you’re replacing your original mortgage loan with a new one. This means you have to pay closing costs again. There are a good amount of fees involved and they can easily total several thousand dollars, so you have to be confident that, whatever your reasons for refinancing are, you’ll end up saving more than the initial expense of closing costs.
Before you start the refinance process, you’ll want to know whether you’ll be assessed a prepayment penalty. Sometimes, lenders will charge you for paying off your mortgage loan early even if you’re refinancing. The fee could be several months’ worth of mortgage payments, and this will dramatically increase the cost of refinancing.
Once you decide to move forward, the first step is applying. As expected, this comes with an application fee. This is non-refundable even if your application is rejected, so do your homework before you get to this step. The application fee usually covers the credit check and certain administrative costs, and in some cases it includes the appraisal. Depending on the lender, the application fee could be anywhere from $100 to $500. If the appraisal isn’t included in the application fee, you’ll need to pay for one yourself.
If your application is approved, the next expense you’ll be responsible for is the loan origination fee, which covers the lender’s administrative and financing costs. This fee is generally one percent of your refinance loan amount (so if you’re refinancing a $280,000 mortgage, you can expect the origination fee to be $2,800). You may also have to pay a separate fee to the lender for reviewing the refinancing documents before closing.
When you’re trying to decide whether to refinance, the best thing to do is run the numbers to figure out how much you’ll save and whether it’s worth the fees you’ll have to pay. If the closing costs are fairly high, it’ll take you longer to recoup the expense in terms of the money you’re saving on a monthly basis.
If you decide that refinancing makes sense, shop around for a lender that will offer you a good interest rate with affordable monthly payments. Prioritize low closing costs and no prepayment penalties. Also keep in mind that the better your credit score is, the lower the interest rate you should be able to get.
Before beginning this process, you need to be clear on your objectives. Most people refinance to get a lower monthly payment. If current interest rates are lower than the rate you are paying on your mortgage, and your credit score is good enough to take advantage of those lower rates, then this could save you a good bit of cash every month.
Keep in mind that in most cases, it’s essentially restarting the clock on your mortgage. If you had a 30-year mortgage for 10 years and refinance at a lower rate for another 30-year mortgage, then you’re in it for the next 30 years rather than 20. This means that some of the reduction is due to stretching out a lower principal balance over a longer period of time rather than actually reducing your rate. If you’re planning to stay in the home for a while, you can save money by refinancing in this way.
Sometimes the opposite is true: you might be able to afford a higher monthly payment and want to save more over the long run by shortening the term of your mortgage. In this instance, you could switch from a long-term loan to a short-term loan through a refinance. You’ll have higher monthly payments but you’ll be able to pay the loan off much more quickly, saving thousands of dollars in interest payments over the life of the loan. When considering this option, closing costs are usually less of a concern.
If you began your homeownership with an adjustable-rate mortgage or ARM, you were probably able to enjoy low monthly mortgage payments in the early years. As with all ARMS, interest rates inevitably begin to rise and so do your monthly payments. You can avoid too big of a hit from increasing payments by switching to a fixed-rate mortgage. These payments may initially be higher than the payment on your ARM, but you’ll at least know that they’ll stay the same.
Conversely, if you know you’re going to be selling your home within a few years, it might make sense to switch to ARM through refinancing. This would lower your rate and your monthly payment until you sell the house.
When you have equity in your home, you can opt for cash-out refinancing. As the name implies, this allows you to turn that equity into cash. You typically need 20 percent equity in the home to qualify. A cash-out refinance can make sense if you have a large purchase you want to make but either don’t have the funds or other financing would be more expensive than the rate you can get through a refinance on your home. It can also be a great way to pay off more expensive, higher-interest debt such as credit cards.
Making home improvements is a smart use of the cash you get from that equity, because you’re ultimately putting that money back into the home and increasing its value and, by extension, the value of the equity you hold. It can also be a good way to finance a child’s higher education or to purchase an investment property.
As with most things pertaining to homeownership, your own circumstances are going to be the deciding factor in which route you take. Be aware of the potential costs, benefits, and risks of refinancing and how they relate to your own financial goals.
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