Questions to Ask When Refinancing Your Mortgage
Borrowers seek to refinance their home mortgages for two main reasons. Refinancing helps borrowers to reduce debt servicing costs through negotiation of better mortgage terms. This is especially true when interest rates trend downwards as they are doing now. Some borrowers also refinance to cash out their home equity. These refinancing plans are embarked upon with the intention of getting some financial relief. However, careless planning or bad advice can lead to the reverse. Consider your answers to the following questions when evaluating your refinancing options.
Are you refinancing to lower your monthly payments?
Refinancing offers an opportunity to build equity faster. This happens when your existing mortgage is replaced by one with a lower interest rate and a shorter repayment period. However, if your objective in refinancing is to lower your monthly payment, your broker may offer a longer repayment period than that on your existing mortgage. While this would reduce your monthly payment, the longer term means that you will be paying more interest over the life of the loan.
Your reason to negotiate a lower monthly payment may be prompted by a desire to switch from a fixed rate mortgage carrying a higher rate to an Adjustable Rate Mortgage (ARM) with a lower rate. On the other hand, you may be at a stage where the fixed rate period of an ARM is coming to a close and you wish to reduce the risk relating to future payments. Remember that it is not only the monthly payments of your existing and refinancing mortgage that you are comparing in this exercise.
Do you plan to move soon?
You should have a clear idea of how much longer you plan to be in your home before arranging to refinance. Check by how much your loan balance will reduce with a new mortgage during this period when compared to your existing one. Consider also the points and settlement costs relating to the new loan that are payable in cash and the interest you will lose by not investing these funds elsewhere. Another factor to consider is your tax savings on the interest and points paid on the mortgage. If the overall savings that are earned during this period exceed your closing costs, then it makes sense to refinance.
Do you really have to cash out your equity?
When funds are needed urgently, some borrowers opt to cash out part of their home equity. Doing so depletes the equity you have carefully built up by paying down your loan. If the market value of homes in your area decline, there is a risk of the new refinancing loan exceeding the upper limit of 80% of the home value set by lenders for a home mortgage. If this happens you will be required to pay mortgage insurance for your new loan.
Another fact that some borrowers fail to realize is that refinancing to cash out results in a bigger loan than the present one. Even if interest rates are low and other terms are satisfactory, paying more interest for a larger loan needs careful consideration. A better alternative may be to borrow the extra funds required by way of a second mortgage while continuing to service the existing mortgage. Compare the costs relating to both scenarios to ascertain which one is better.
Are you financing your closing costs?
Closing costs in the form of points and fees are upfront cash payments that are required when refinancing your mortgage. Some lenders agree to finance these costs by including it in the new mortgage. This increases the size of your mortgage and the interest that you will pay over the term of the loan. At times such higher amount may even result in your having to pay mortgage insurance. A careful analysis of the costs and benefits relating to such offer will indicate if it is viable.
Are you receiving good advice from your mortgage broker?
The mortgage broker or agent who offers mortgage refinancing, gains only if you actually avail of such funding. While most brokers and lenders adhere to the ethical standards set by the mortgage industry and associations they belong to, there are others who may lead you astray. Ask your broker for references and check whether your broker or lender is licensed to practice in your State. Safeguard yourself by getting a minimum of three quotations before signing a contract. The "Truth in Lending Act" requires a lender to disclose details of closing and financing costs at the time of signing the loan contract. This Act also gives you the right, under certain circumstances, to rescind your contract within three business days of signing if you do not wish to proceed with the mortgage transaction.
Get these questions clarified during the refinancing negotiations. If handled prudently, refinancing offers a way to reduce your debt burden. Do not be lured only by low interest rates or a need to cash out your mortgage. Consider also factors such as how many years you have left on your present mortgage, the type of mortgage you have and how much longer you plan to be in your home. Overall, they can lead to a wiser financial decision.