Given the current real estate loan (mortgage) interest rates, and the unfortunate reality that many people owe more on their home than it's worth, it's no wonder the Refinance Home Mortgage industry is booming. And unlike years past when greedy lenders were anxiously handing out money hand-over-fist to homeowners who probably shouldn't qualify, these days it's all about softening the financial burdeon of an overpriced mortgage - or more appropriately, finding a more affordable mortgage vehicle.
But don't think that it's only those who are drowning in financial debts are the only ones seeking a refinance. Even those who are fiscally and monetarily sound are refinancing mortgages. There are any number of reasons why, but perhaps the most compelling is the fact that almost every home owner in America is making mortgage payments on a home that's not even worth the value of the loan! Talk about disconcerting. And as America - and the rest of the world, for that matter - come to grips with a stagnant (and in many areas, tumbling) housing market, the government powers-that-be have overhauled the mortgage industry to both encourage home buying and also to help out those saddled with upside down loans on vastly depreciated values.
I'll go into more detail about why a strong real estate market is important to any economy in a moment, but for now let's help you decide if a refinance is a viable option given your current situation. First off, let's get down to the basics.
What Is A Mortgage Refinance?
A refinance (or "Refi," as it is sometimes called) is simply the process of taking out a new loan to pay off the balance of an existing loan, or in this case, a mortgage (I know it's basic, but don't forget that a mortgage is just a fancy word for "Home Loan").
Why would anybody want to do this? Because it can save them money. And in many cases, it can save tens of thousands of dollars over the life cycle of the new loan.
There are two main factors. The first is that a typical homeowner has paid down at least some of the mortgage principle between the time they purchased the home and when they are seeking a refinance. While this is not always the case, making 30 years worth of payments on a lower total value almost always results in cheaper monthly payments.
The second, and by far the most common, is a Lower Mortgage Interest Rate. The lower the mortgage rate, the lower the payments usually are. Even if a person hasn't reduced their loan principle by a single cent, a lower interest rate almost always ensures lower monthly payments. And the lower the interest rate savings compared to the original mortgage, the more those savings add up.
Home Equity Refinance
Not everybody who refinances a home does so to reduce their monthly house payments. Some people refinance their mortgages to cash out the equity that's built up over the years. What is equity? It's the condition when the value of the home exceeds the mortgage principle. This is common amongst investors and long-time home owners, and is often a best-option for leveraging financial investments.
Here's how an Equity Refinance works: Let's say your home is currently worth about $200,000; but either because you scored a great deal or because you've purchased it decades ago and the combination of your payments and the overall real estate growth trend, you only owe $100,000 on your mortgage. Refinancing to the current $200,000 value lets you "cash out" that $100,000 difference. Sure you'll now be making 30 more years of house payments on a $200,000 mortgage, but you'll also have a cool $100,000 in your pocket.
During the recent U.S. real estate boom, this became a common situation for almost every American homeowner. Thanks to soaring home prices, it seemed like the value of nearly every house jumped up the instant it was bought - which drove many people to cash out the equity and take on a more expensive loan. Sadly, those people are now saddled with mortgages that far exceed their homes' values.
Refinance Home Mortgage - Is It Right For You?
Finally! The part you've been waiting for. If you've been considering refinancing a home mortgage, here's what you'll need to know in order to get the most value out of the deal.
First, know your basic mortgage types. Even now, mortgage companies offer a wide variety of mortgage systems, and some may benefit your current and future situations while others could actually make them much more difficult.
Here's a list of the most common types:
- Fixed Rate Mortgage
- Adjustable Rate (or "Arm" - short for "Adjustable Rate Mortgage")
- Interest Only Mortgage
- Reverse Mortgage
Let's break these down and see which is right for you.
Fixed Rate Mortgages
Fixed rate mortgages are exactly what they sound like. The interest rate that you sign up for stays the exact same throughout the life of the loan term. This is a very safe and conservative option, because you'll always know what your payments will look like. If interest rates go up, it won't affect you. And if they go down... well, they won't affect you either. So it's kind of give and take. But just remember that you're not necessarily stuck in a "bad mortgage" if the lending rates drop, because you can always refinance at that lower rate if the situation warrants.
Generally speaking, if you can find a mortgage rate that's a couple of points below your current rate, most experts would say "Go for it." Just remember that almost every mortgage broker charges closing fees, which can add up to thousands of dollars, so make sure to include that in your overall equation; many people fail to realize this, and end up paying a $5,000 closing cost to save $50 per month. While it will eventually become a worthy trade off, it will take more than eight years before the savings offsets the fee.
Adjustable Rate Mortgages, or "ARMs"
Unlike a fixed rate mortgage, an ARM's rate will fluctuate based on the current financial climate. As the interest rates go up, so too will your mortgage rate (and ultimately, your monthly payment). But the upside is that your rates will also go down if/when the lending rates drop. While not considered as "safe" as a fixed rate mortgage, many real estate professionals still cling to ARMs, including real estate investors who can capitalize on a currently low interest rate, then sell (liquefy) the property before the rates crawl back up.
Interest Only Mortgages
Interest Only Mortgages have lost considerable steam amongst most home buyers and refinancers recently, primarily because the monthly payments never include any principle. Long story short, if you pay every single payment to the penny, after 30 years you'll be left with one humongous final payment. How big? It's the entire value of the loan. This is often referred to as a "Balloon Payment."
While many predatory lenders used these to get less-than-qualified home buyers into homes they probably shouldn't have been able to afford (after all, the monthly rates will be lower since you're not paying down any principle), and thus tarnished the reputation of such mortgages, they still have their uses. For instance, those with fluctuating incomes, such as commission workers or the self employed, this can be a huge safety net. So long as you pay more than the minimum payment when times are good, you'll knock down the principle just as you would with any other loan type. Then during the lean months you can fall back on the lower "interest only" minimum payment.
Keep in mind that this is probably best for only the most advanced budgeters, as it is very easy to fall behind without a disciplined approach.
Again, investors still like interest only mortgages, especially short-term investors or "house flippers." Because they don't plan on keeping the house any longer than a few months, and then selling at a much higer price than they paid, they can minimize the few mortgage payments they'll have.
Drawbacks of Refinancing A Mortgage
While a strategic refi can save you tens of thousands of dollars over the course of the loan, there are some very important reality-checks to keep in mind. Failure to properly consider these could upset your finances, and even cost you more money in the short and long term.
Like I mentioned early, nearly every mortgage broker and home lender charges Closing Costs. These are effectively surcharges for the time and effort of the lender. These costs almost always add up to thousands of dollars. So even if you refinance to a lower monthly rate, it could take years - maybe even decades - before the monthly savings offset the one-time closing cost fee.
Extended Loan Term
Once you sign the papers for a new loan, you're starting back at the beginning in terms of monthly payments. For instance, if you refinanced your existing 30-year mortgage seven years into the term (meaning you've got 23 years left before the balance is paid), and used another 30-year mortgage to do so, the refinance just added another 30 years to your home loan. While the payments might be lower, keep in mind that you've effectively just turned that 30-year mortgage into a 37-year mortgage.
Current Home Value Vs. Remaining Mortgage Principle
If your home isn't worth as much as you owe, you'll need to come up with the remaining value in cash. Banks and other mortgage companies typically aren't willing to finances - or in our case, refinance - anything beyond its current market value. So if your home's value has dropped below the remaining mortgage principle, you'll have to compensate by paying down the difference before you'll likely be eligible for any home mortgage refinance.
With the proper planning and careful selection, you can often refinance your home loan to meet your current financial stipulations. But let me again emphasize the "planning" and "selection" parts. While a refi can reduce your financial overhead or even leverage other investments, it can also cost you your shirt if not done properly. Your best bet is to speak with several mortgage companies and/or brokers with solid reputations, as they'll have the up-to-date information and tools (like mortgage calculators and amortization programs) to help you make the right refinance home mortgage decision.