The holidays are coming up and cash is tight for a lot of us. Plus, a new year is about to start. That makes it a good time to think about reorganizing our finances and finding ways to spend less and save more. That may mean cutting back on restaurant meals or movies. It may mean really taking advantage of coupons and deals. Those smaller changes can really add up – but what about your big bills?
For most folks, a mortgage is the biggest bill every month. You can’t use a coupon to lower it, but there is a way to make those payments easier: refinancing.
What is mortgage refinancing?
When you first took out your mortgage loan, you had to agree to a number of aspects of your loan. Most importantly, you picked a “term,” or a length of the loan. Most commonly, that’s 30 years. You also agreed to an interest rate. That may have been a fixed rate, which means you pay the same rate every month. Alternatively, you may have agreed to an adjustable rate. An adjustable rate mortgage (ARM) has an interest rate that changes every month based on certain factors in the market. That’s an advantage when rates drop, but can leave you with unexpectedly high payments when rates rise.
The terms you chose may have made sense at the time, but times (and rates) change and you may want to adjust those factors to make your payments easier. That’s where refinancing comes in.
There are two main types of refinancing: rate-and-term refinancing and cash-out refinancing. With rate-and-term refinancing, you renegotiate the original agreement with your lender. That may mean shortening or extending the term of the loan, which allows you to pay it off faster or make smaller monthly payments over a longer period of time. It may also mean changing your ARM to a fixed rate mortgage to take advantage of low rates. Cash-out refinancing means taking out an entirely new mortgage for more than your current mortgage. For example, say your current mortgage balance is $100,000. You can take out a new mortgage for $120,000 and use $100,000 to pay off your old mortgage. Then you take the remaining $20,000 in cash.
Should I Refinance?
As with most financial questions, that depends on your unique circumstances. Refinancing costs money! You’ll typically have to pay:
- A mortgage application fee of up to $500
- An appraisal for $200-$700 (so the bank knows the value of your home and can decide how much to lend)
- A loan origination fee of 1 – 1.5% of the value of the new loan (if you want to refinance $100,000 of mortgage loan, you’ll have to pay $1,000 – $1,500)
- Title search and insurance of $600 – $1,200 (to ensure that you actually own the home and protect against problems with the title)
- Local recording fees, which vary by area but can cost several hundred dollars
You may also have to pay the fees associated with your particular mortgage loan. And more importantly, your amortization will start over. “Amortization” refers to how you pay off interest and principal over time. Your earliest mortgage payments are mostly interest payments, since you pay the interest rate on the entire loan every month plus a certain amount of the principal. By the end of your loan, you’re paying a small amount of interest and a large chunk of the principal. So, remember that a refinance means a whole new amortization schedule. That means you may end up paying more interest over the long run.
So how do you decide if a refinance is right for you? You’ll have to do a little bit of number crunching. First, take your original mortgage and figure out how much it’s costing you. Essentially, you’re looking at your monthly payments and also your total interest payments over time. Then, talk to your lender (and potentially other lenders) about refinancing. Ask them about their fees and ask them to give you an amortization schedule for a new loan. You can compare your current monthly payments and your total interest payments with those from a new loan. If it’s cheaper to refinance, then refinance!
Sometimes that math can get complicated, especially if you’re already behind on your mortgage payments. At that point, it’s worth it to talk to a financial adviser (your lender will have advisers) or an attorney to determine whether you qualify and how a refinance will affect your monthly payments and your loan overall.
The Bottom Line
Mortgage loans are expensive – period. A home is the largest purchase most people will ever make. So it’s worth the time and effort to consider your loan and make sure you’re getting the best possible deal. If you’re having trouble making those payments every month, a refinance may help ease the pressure on your budget.
If you’re behind on your mortgage and refinancing isn’t an option or won’t lower your payments enough to let you make ends meet, you may want to consider other debt management options. Contact us today for a free case evaluation and consultation to learn about your options.