During the recent credit crisis, refinancing is becoming an increasingly popular word. In simple terms, refinancing means adding more debt to an existing mortgage, only with different terms that allow you to pay less in your monthly mortgage and use the cash to pay off your high-interest credit cards.
The measures of U.S. government to restore the real estate market have led to a significant drop of the mortgage rates that can offer you the opportunity to save money by refinancing. Currently, mortgage interest rates are close to their historical lows. 30-year fixed rate is at 5.08% (as of 12/17/09), whereas one year prior it was at 5.53%. Similarly, 15-year fixed rate is at 4.48% (as of 12/17/09), whereas one year prior it was at 5.26%. Even better, 1-year ARM (adjustable rate mortgage) is at 3.92% (as of 12/17/09), whereas one year prior it was at 5.70%. (Source: Bloomberg). Therefore, by refinancing your mortgage now, you will have lower mortgage monthly payments. The math is simple: lower mortgage rates, lower mortgage payments.
However, as the mortgage crisis is still on, you should implement solid refinancing strategies to ensure that you save money on closing costs.
a) Refinancing from an adjustable rate mortgage (ARM) to a fixed rate mortgage (FRM)
If you took your mortgage loan with an adjustable rate mortgage (ARM), you should probably consider fixed rate refinancing. The logic is the following: adjustable rate mortgage, as the name implies, will adjust at some point. Typically, adjustment ranges between 2% to 5% on the initial adjustment. Refinancing before adjustment to a fixed rate is a good strategy because you avoid considerably higher rates in the following years. Home payments are subject to fluctuation, which will make any financial planning extremely difficult and you may not be able to be in control of your finances. Therefore, refinancing to a fixed rate after fifteen years can save you from considerably higher payments and you can secure a good rate when interest rates are low.
b) Refinancing with a cash down-payment
Another successful strategy to retain all of the equity is refinancing with a cash down-payment. When refinancing, you are obliged to pay the closing costs, which range between $3,000 and $7,000 as of August 2009. This obligation increases your monthly payments and may considerably decrease your equity. Also, in case you decide o sell your house, you will get less money back. By doing a cash-out refinancing, refinancing amount will be higher than your current principal balance leaving you the extra funds as cash.
c) Calculating the refinancing break-even point
Calculating the refinancing break-even point if you plan on paying closing costs upfront is very important in developing your refinance strategy. Until a full reimbursement on these closing costs that will lower you monthly mortgage payments, you actually don’t save any money on refinancing. For instance, if closing costs are $3,000 to lower your mortgage by $100, your refinance break-even point if 30 months. If you sell your property or refinance again prior to 30 months, you lose money on the deal.
d) Getting a no-fee loan
Instead of getting a traditional mortgage refinance that has upfront closing costs, you may get a no-fee loan that has a higher interest rate, but incurs no upfront closing costs. Especially if the no-fee loan rate is lower than your current mortgage payment, a no-fee loan is the right choice. A possible drawback is that the difference in the rates of a traditional mortgage refinance and a no-fee loan is relatively large as a result of the credit crisis.
You should consider refinancing with the bank that already holds your mortgage. The main advantage is that you have already developed a relationship with that bank, you are their customer and therefore, paperwork for refinancing will be considerably less. Besides, you are more likely to deal with the same representative with whom you have originally dealt for your initial mortgage, which may possibly lead to less closing costs as well.
The fact that lenders have tightened the refinancing criteria, leave you with fewer refinancing options available today. The strategy that you will choose is also subject to different factors including how long you plan to keep the mortgage and what do you plan to do with the money. For instance, if you plan on staying at your home for less than 10 years refinancing your ARM to a fixed rate it’s not the best strategy. When your ARM was originally adjusted was at a very good rate and refinancing it in such a short period such as 10 years will incur refinancing expenses (attorney fees, appraisal fees and so on) that will cause it to lose much of its value. On the contrary, if you plan to stay at your home for 20 years or more, refinancing your ARM to a fixed rate and save yourself from the market fluctuations is the best strategy that will save you a lot of money over the life of the mortgage.
Overall, refinancing enables you to spread your mortgage over another 15 to 30 years depending on the terms agreed. For instance, if you have already been paying your 30-years mortgage for eight years, you have twenty-two years left on your house. By refinancing, you can spread you loan over another 30 years maximum and pay much less per month because you are giving yourself another eight years to pay back the same amount of money.