Are you considering refinancing your home? Low interest rates are currently in your favor.
The refinancing plan that's right for you and your family depends on your current financial situation. Is your home underwater and you need to secure a lower monthly mortgage payment to avoid foreclosure? Are you in a stable situation, but want to take advantage of today's lower interest rates? If so, generally a .5 to .625 (1/2 to 5/8) of a percentage point lower interest rate recoups most of the refi costs. Would you simply like to shorten the term of your loan to pay it off faster?
"Rate isn't the only indicator of when it's a good time to refinance," explains Greg McBride, Chief Financial Analyst for Bankrate.com. "There are also other instances, changes in your life circumstances - maybe you got divorced; maybe your family is growing; or you have to add an in-law suite, in which case you may be looking at doing what's called 'cash-out refinancing': you refinance and borrow a little bit more money to pay for whatever upgrades are needed to the home."
Regardless of the path you choose, the steps involved to refinance your home are similar to the steps you took when first buying your home. First, there will be an assessment of your ability to repay the loan. This will involve a credit check, and an evaluation of your outstanding debts and assets, so take these into consideration. You can check your credit score and read your credit report for free within minutes using MoneyTips' Credit Manager.
Generally, there will be an appraisal of your property, a home inspection, title search, and a survey —all items that add up to extra costs on the front end.
An estimate of your refinancing costs include:
- Application Fee: $100-$300
- Loan Origination Fee: Up to 1.5% of principal
- Points (up-front money to reduce interest rate): 0-3% of principal
- Home Appraisal: $400-$800
- Home Inspection: $200-$350
- Attorney/closing fees: $500-$1000
- Homeowner's Insurance (if required): $300-$1000
- Title Search: $700-$1,000
- Survey: $150-$400
This doesn't consider any prepayment penalties on the existing mortgage or fees for any federally backed assistance programs such as FHA or VA loans. Once all costs are factored in, a typical refinance cost is about 3-6% of the principal.
So-called "no-cost refinancing" still has costs — they are either rolled into the principal, or the lender agrees to pay them upfront for an increase in the interest rate.
With all these costs, why bother? Because, in the long run, you may be able to save a significant amount of money by switching from a fixed-rate loan to an adjustable-rate mortgage (ARM) or vice versa. Changing the duration of the loan can also save you money.
Consider the following: dropping a fixed rate from 6% to 5.5% on a $200,000 loan will lower your monthly payment (principal and interest) from $1,199 to $1,136 per month. Over one year you will save $756, or $11,340 over 15 years, or $22,680 over 30 years. If you can handle higher payments, shortening the duration of the loan has an even more dramatic effect. That same fixed 30-year, $200,000 loan has a total of more than $231,000 in interest costs over the 30-year life of the loan. If adjusted to a 15-year rate at 5.5%, the total interest drops to around $94,000.
What kind of rate should you seek? Current fixed rates are at historical lows and are hard to beat, but you may want to consider an ARM for an even lower rate if you know you will not be staying in a house for very long (or can find affordable refinancing before the adjustment period of the ARM kicks in). Make sure to compare the annual percentage rate (APR) with the interest rate. The APR takes into account other costs. A large difference may mean excessive fees or unusual rate adjustment assumptions. Check with your lender and make sure you understand the implications.
If your home is underwater (that is, you owe more on your home than it is currently worth), you may consider the government's HARP (Home Affordable Refinance Program). If you have kept up with payments and meet certain qualifications, you can refinance for up to 125% of the loan total.
Refinancing your home can cost thousands of dollars, so do your homework. It can also save you thousands of dollars in the end.