In the "old days" lenders used to have very high closing costs so you would only refinance your home loan if the rate went down 2% or so. This would give you a payback of closing costs in about two years for typical loans. Today, many new programs make refinancing your home loan a wise move even if rates are flat. This article will examine refinancing your home.
Definitions
A home refinance is where you replace a current home mortgage with a new loan.
PMI is Private Mortgage Insurance that protects the lender against the loss of its investment in your home.
Home equity is the amount of money you would get after selling your home and paying off the lender but before paying selling fees.
Nonrecurring closing costs are costs to close a loan that only happen once. These may include points, the appraisal, documentation fees, etc.
Why Refinance?
There are many reasons to refinance. The most common reason to refinance is to lower your payments when interest rates fall. The rule of thumb is you should refinance any time your savings will pay back the closing costs over a period of time shorter than how long you plan to own your home.
Another reason to refinance is to eliminate costly PMI. If you paid less than 20% for a down payment, then lenders usually require PMI. I've seen PMI as high as 0.6% of the loan amount so a $250,000 loan would have you paying $1,500 a year just for insurance! When your house appreciates so you have 20% equity, then you should refinance and eliminate this PMI payment. It might even make sense to use any cash windfalls to "buy down" your mortgage with a refinance to an 80% loan and eliminate this very costly insurance that is unnecessary once you have 80% equity in your home.
Many people refinance their homes to take money out to remodel or do major home repairs. This often makes sense when you have many years of appreciation and any money taken out would still have you with greater than 20% home equity. I DO NOT recommend people take money out of their homes to buy autos or other items that don't last as long as a home.
Some people discover they have had several raises since their first mortgage and they can afford to pay more every month. If you are in this lucky group, then you can refinance a 30 year loan to a 15 year loan and get a better rate while saving thousands and thousands of dollars on interest.
Pitfalls of a Home Loan Refinance
If you refinance your home loan every 5 years for whatever reason, and you make the minimum payments, then you will NEVER pay off your mortgage unless you refinance for a shorter term and or pay more than the minimum payment.
I do "no cost refinances" often and I always calculate my new payment that will make sure I pay off my home 30 years from when I took out the first mortgage. Since rates have been dropping, my payments are still smaller after a refinance but I will have my house paid for 30 years after I took out my first loan.
No Cost Home Refinance
"No cost refinances" are often available if you have a large loan and some of the "lender rebate" given to the mortgage broker by the lender to process your loan is used to pay your nonrecurring closing costs. For many years, you were able to refinance as often as you wanted and some people did it every 3 months! Now the lenders have gotten a bit smarter and you have to pay a penalty if you refinance too early. For example, my current jumbo loan is at 5.75% but I have to pay a 1.6% penalty if I refinance before 3 years.
Resources
I have a friend that does all types of home loans for people in California. Like me, he works out of his home to keep expenses to a minimum but pools his loans with others doing the same so he gets great rates. Costs are passed on to us so I've yet to find a cheaper place to get my loans. Send me an email with specifics if you want details on how to contact him and live in California.
I highly recommend reading or skimming a few good books before you get started as the cost is tiny compared to what you will can save on a home mortgage with a good refinance.
How to Get the Best Home Loan, 2nd Edition by W. Frazier Bell
Mortgages For Dummies® by Eric Tyson, Ray Brown
How to Save Thousands of Dollars on Your Home Mortgage by Randy Johnson
In Conclusion
Refinancing your home mortgage can be a great way to save money and or improve your quality of life. Feel free to ask any questions on this in our discussion area for this article.
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DISCLAIMER: Answers & my words are general in nature, are not meant as specific investment advice, and do not necessarily represent the opinion of anyone but Kirk. Individuals should consult with their own advisors for specific investment advice.
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