What Is a Mortgage Refinance
Refinancing is defined as taking one mortgage loan and replacing it with another. A refinance is useful for homeowners who want to lower their mortgage payments, change the length of their existing mortgage, or taking cash out for any worthwhile purpose.
Historically, refinance transactions were used mainly when interest rates and mortgage rates were falling. Homeowners would seek to refinance at interest rate that would be below what they had on their home loan when their first bought the property.
Reducing the existing rate on a mortgage or altering the existing length of your loan is referred to as a rate and term refinance. A rate and term refinance isn’t always used by someone to lower his or her payment or change the term of the home loan. In today’s chaotic interest rate environment numerous homeowners are refinancing into fixed rate loans from adjustable rate loans regardless of what the difference in mortgage rates may be. Some homeowners make use of a rate and term refinance to avoid the rate changes coming due on an adjustable rate mortgage and merely refinance into yet another adjustable rate loan with a lower start rate.
Refinancing for additional cash to pay for bills, other loans, home improvements or any other purpose is categorized as a cash out refinance. Paying off any other debts or using the funds from the proceeds of a new refinance for any thing other than paying off the existing mortgage and the costs associated with that mortgage loan, is considered a cash out refinance. A cash out refinance requires that there be sufficient equity in the property to cover the amount of cash requested. If a homeowner has paid down their mortgage for a long period of time or if property values have risen since the time the property was purchased, the homeowner has probably built up some equity in the home that can be accessed with a cash out mortgage refinance.
Refinancing an existing mortgage loan and taking out a new home loan can yield substantial monthly savings by reducing the mortgage rate, shortening a mortgage term to build home equity faster, changing the mortgage product from an adjustable rate mortgage to a fixed rates loan or a fixed rate mortgage into a an adjustable rate mortgage or taking cash out. However, mortgage refinancing comes with a cost to obtain the new home loan. It is essential that home owners who are considering a mortgage refinance transaction evaluate both the costs and benefits before filling out a mortgage application.
No matter which refinancing option you choose be sure to research it carefully. Your refinancing decision depends on current interest rates and mortgage rates as well as your own financial needs. Compare the available mortgage loan programs, gather information, and check out online mortgage calculators to see what type of mortgage refinancing will work best for you. Take your time to decide if refinancing is right for you before starting this new home loan transaction.
Why You Should Own a Home
Buying a home is not for everyone. Some people like the flexibility that comes with renting. When you rent, you can live in a neighborhood for as little or as long as you want. You’re also free of most maintenance responsibilities – your landlord usually handles repairs. But home ownership is one of the best ways for most people to build wealth and the psychological reward of home ownership in our culture is incalculable.
Of course there are many other reasons owning a home can be beneficial. Here are few of the most common.
Building Equity with a Mortgage Loan
When homeowners make payments on their mortgage loan they are building equity as they pay they slowly pay the home loan off. In the early years of most mortgages, the majority of your monthly mortgage payments go towards interest on your loan. Over time, an increasing amount of the monthly payment goes toward reducing mortgage balance, or principal. As you make your monthly mortgage payments, you reduce the principal and increase your share, or equity, in your home’s value. These payments are like a forced savings plan that builds equity, which is benefit you will not enjoy with rent payments.
Appreciation
The biggest factor creating wealth with home ownership was appreciation. Even though real estate can experience temporary downturns, homes typically appreciate in value. Over time housing appreciation has become a valuable wealth creator.
Gain Tax Savings
Home ownership builds wealth through the tax deductions allowed by the IRS. You are allowed to deduct most mortgage interest and property taxes from your federal income tax and from some states’ income tax. These deductions can mean you build wealth by paying less in taxes each year. After calculating your taxes, you may find that it’s cheaper for you to buy than to rent. When comparing mortgage rates and home loan costs it can be important to evaluate the after tax cost of the home loan. The deduction of interest expense on a home mortgage is one of the remaining interest deductions available making this advantage to home ownership.
Payment Stability
If you select a fixed rate mortgage, you will pay the same monthly principal and interest payment for the term of your home loan. Rent contracts or leases typically run year to year and the payment amount of rent is often at the mercy of the market. When inflation leads to higher prices and incomes and expenses rise, the fixed rate mortgage payment stays constant. You are now paying back a mortgage loan with less precious dollars as inflation eats away at its value. Of course, your home’ total monthly housing expense could vary if tax and/or insurance expenses change but these costs are relatively small considering the total cost of housing.
Risky Home Mortgages
Mortgages with risky terms or ones based on dicey credit standards are mortgages that can cause you problems. High risks mortgages may have an appropriate use in the mortgage marketplace for those borrowers who do not meet conforming guidelines. Borrowers who exhibit the needs of a high risk loan commonly needed a mortgage loan due to slow credit, extremely high loan amounts relative the homes value, or loans to speculate on real estate. In an earlier period, high risk loans were introduced to serve just this market segment. High risk loans were designed to relax the requirements for credit standards, little to no down payments and excessive debt ratios. Sub prime loans are the typical loan type we think of regarding high risk lending. As of recent, these loans have morphed and have now been used for a variety of purposes and sold to borrowers who don’t fall into a category of needing a home loan used for high risk transactions.
A mortgage is a loan that provides you with the resources to buy a home. If you aren’t educated about the types of loans that are available, some lenders may attempt to sell you a mortgage with lots of features and variations that don’t apply to your particular needs. There are many different products out there and some of them are dangerous. Make sure you know about high risk mortgages that can potentially get you in trouble. With slightly higher rates or conditions that are pushed onto the borrower, many lenders find offering these products more attractive for their overall rate of return.
Option ARM (adjustable rate mortgage) loans are probably the most dangerous type of mortgage. These loans give you a lot of flexibility when your monthly payment is due: pay a little or pay a lot. However, you can get in trouble very easily. Option ARM loans are mortgages that give a borrower a choice on how much a given payment is. This seems like a valuable feature inasmuch as you have the flexibility to respond to month to month circumstances. You can make a minimum payment, a full payment, or an interest only payment. These loans are filled with pitfalls.
First, you don’t build equity unless you make the full payments that you would make with a conventional mortgage. Given a choice between a large payment and a small payment, which one will you choose? With the smaller payments, you’ll actually owe more on your house at the end of the month than you did at the beginning, a situation of negative amortization.
Another peril of an Option ARM is that small payments will not last forever. Sooner or later the bank will want to put you back on schedule to pay the loan off, and will “recast” your loan at given intervals, or when you owe too much on the home (110% or 120%, for example) due to negative amortization. When they recast, they set the loan on track to fully amortize over its remaining life, and your minimum payment can increase sharply. If your budget can’t afford this increase, you’re in trouble.
An option ARM is almost always a bad idea. The mortgage rates on option ARM’s are initially a very low teaser mortgage rate. As soon as the introductory rate period or teaser rate is over the fully adjusted rate on this loan is as high as a 30 year fixed rate loan. Sometimes, the fully adjusted rate is distinctly higher than a 30 year fixed rate. If the introductory rate lasted a reasonable length of time, the low initial rate may have some value. The problem with the option ARM is that this teaser rate expires anywhere from one month to six months. The option ARM is clearly one of the worst loan products that were sold on a wide scale and in the category of Arms has the least favorable terms.
Interest only loans give you the ability to pay less each month because you’re not repaying principal. You can set up your own amortization schedule, that is, a schedule for paying back principal. However, you can also end up without any equity in your home – and possibly have to write a check if your home loses value and you want to sell it. Interest only loans should be used by the most disciplined of borrowers. The interest only option allows for a lower payment but, the principal has to be paid back at sometime. Delaying the repayment based on estimates of future home appreciation or the ability to refinance at a later date under more favorable terms may be a gamble that can cost you your home.
The home loan programs that have yielded some of the biggest problems this year are the no income verification loans and the various permutations of them. Alt-A, no income, no doc, and stated income are all terms to describe similar loan programs. These loan types don’t require the borrower to document their income. For the self-employed borrower who would employ aggressive techniques for write offs against their revenue stream or income, these loans filled a need. Recently, the use of low document income loans or no document income loans were used for wage earners and borrowers who had income that would have been easily verified. These mortgage loans may allow a borrower to qualify for a loan that under normal underwriting guidelines would have been impossible. The risk and cost for the borrower is now trying to figure out how to make the monthly payment on a loan based on income that they did not actually earn. Foreclosure figures on this loan type are certainly proving that not verifying income is not a free ride to homeownership.
Many of these loans have in fact opened the door for increased number of borrowers to become homeowners. Some of these home loan products may be appropriate for you. If you’re thinking of using one of these loans make sure you understand the risks. Don’t be tempted by the reassurances of a mortgage lender that profits at your risk. It may make more sense to buy a less expensive house with a fixed rate mortgage or repair your damaged credit first. Do your research and comparison shop before making the leap.