Refinancing your mortgage can provide you with a monthly windfall of extra
cash, shorten the term of your mortgage and help you build equity faster.
When you refinance your original mortgage, you swap it for another, often
because the rate of the new mortgage is cheaper. With the cheaper rate comes
smaller monthly payments and extra cash each month.
Changing the rate
Let's say back in 1994, you financed $250,000 for
a new home at the going fixed jumbo rate of 9.5 percent. Your principle and
interest payments are $2,102.14.
With your mortgage balance at or below the current $240,000 conforming loan
level today and if you qualify for today's rates—which could be as low as 7.5
percent—your monthly payments would be only $1,678.12.
That's a $424.02 difference.
The scenario doesn't include points and other costs, the specific payoff
balance on your old loan or the cost of your new loan, but you get the general
idea.
The refinanced mortgage could also save you the cost of private mortgage
insurance. If you put less than 20 percent down on your original mortgage, your
lender likely saddled you with the coverage. If your refinanced mortgage is less
than 80 percent of your home's value today—a likely scenario given current
appreciation rates--you won't have to pay PMI premiums of $50 or more a month.
Refinancing a fixed rate for an adjustable rate mortgage (ARM) can save you
even more a month. Today's 1-year adjustable rate of about 6.5 percent would
cost you only $1,516.97 on a $240,000 loan.
A refinance from a fixed rate to an adjustable is a particularly good idea if
you know you'll be moving soon and could use the savings from a lower payments
to put toward your new home.
Other options include switching from one ARM that's been adjusting up for a
few years to a cheaper new cheaper ARM or to a fixed rate--even if it's more
expensive today--to lock in your payments for the remaining term of the loan and
ward off further increases from the old ARM.
Changing the term
Also consider refinancing to change the term of
the loan. While a shorter term loan's monthly payments may be higher, you'll
build equity faster and save hundreds of thousands of dollars over the life of
the loan.
A 15-year conforming loan at the recent average rate of 7.3 percent costs
$2,197.65 a month in principal and interest, compared to $1,678.12 a month for a
30-year loan at the 7.5 average going rate.
However, halfway through the term of the 15-year loan, your balance will be
$151,959.76. Seven and a half years into the 30 year loan, you'll still owe
$218,569.14.
Over the life of the loan, the 30-year deal will cost you a total of
$604,116.78 in principal and interest, while the 15-year loan will put you back
only $395,573.95.
Cashing in your equity
Fast appreciating home values could also
encourage you to refinance for a larger mortgage to pull out equity, say, to
consolidate bills, perform home improvements, buy a new car, pay for your
child's education or meet other financial needs.
Provided your new rate is comparatively low enough and you don't use too much
equity, your refinanced loan's payment actually could be cheaper each month than
the old mortgage.
You also have the option here to shorten the term of the new loan and recoup
your equity faster.
Don't forget, with all refinanced mortgages, unless you do shorten the term,
you begin again with a 30-year mortgage. Add the cost of the new loan to what
you've already paid before the refinance, and your bottom line could be more
than you can afford over time.
Also, if you need to refinance for more than 80 percent of your home's value,
the financial benefits dwindle. You might be better off considering non-equity
loan options.
Automatic refinance loans
A growing number of lenders also offer
special mortgages that act like an ARM in reverse.
Called "automatic refinance mortgages" or "reverse-rate mortgages," the loans
come with a guarantee that your interest rate will drop by as much as 1.5
percentage points below your starting rate--even if market rates are higher at
the time.
Designed primarily to give less creditworthy borrowers a chance to prove they
can make mortgage payments on time and over time, the loan comes with annual
interest rate decreases spread out over a couple of years. After a few
adjustments down, the rate becomes fixed. You must make all payments on time,
maintain a good credit standing and not fall below the income level you listed
on your loan application.
Here's the catch: Just as an ARM begins with a cheaper rate than a fixed
rate, reverse-rate mortgages generally begin higher than traditional mortgages.
It's a gamble that once your loan rate hits bottom, your rate will be
competitive with existing rates.
