What to know before you refinance |
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Gwizdz recommends a customized approach that balances the borrower's need to reduce the monthly payment and make progress toward repayment of the loan. That might mean a new loan with a 20- or 25-year term or perhaps a term of 26, 27 or 28 years.
"We see people who bought a house in 2000, refinanced in 2003, refinanced in 2006 and are now going to refinance again. They have owned their home for nine years, and they still have 30 years left on their mortgage," he says. "They keep focusing on the fact that the payment is lower, but multiply the payment times the number of (additional) years that you are going to have to pay it, and you are actually going backward."
Fifteen-year loans have been a popular choice for homeowners who want to refinance. But Walters believes these shorter terms are appropriate only for homeowners who have substantial savings and excellent job security. Without those safety nets, he argues, there is a substantial risk that the significantly higher payments on a 15-year loan could become burdensome if you lost your job or suffered an illness or disability in the future.
A safer way to pay off a loan more quickly is to make payments on a 30-year loan as if the term were only 15 years. That way, "if life happens to you, you'll have the ability to fall back on a lower payment," he says.
The answer to the longer-or-shorter conundrum may depend on your response to a simple question, suggests Joe Metzler, a mortgage specialist with Mortgages Unlimited in St. Paul, Minn. He asks: "Do you need to lower your payment because times are tough or are you just looking to take advantage of today's rates?" If a lower payment is your objective, a longer term might be appropriate. If your motivation is to capture a low rate, you might want to consider a shorter term.
Mortgage insurance
Nationwide drops in home values may present a challenge for homeowners who want to refinance because a higher loan-to-value ratio can trigger the need for mortgage insurance. This issue "is killing a lot of the enthusiasm" to refinance, Metzler says. If you'd like to refinance but are short on equity, you should still do the math because your mortgage insurance payments may be tax-deductible and could be eliminated if your equity increased in the future.
Discount points
A similar break-even analysis can help you decide whether to pay discount points to buy down (i.e., reduce) the interest rate on your new mortgage. Here's an example that assumes a half-point discount on the interest rate for a payment of one point, which is equal to 1 percent of the loan amount.
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| Example: Calculate break-even analysis |
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| Loan amount: |
| Term: |
| Payment at 5.5 percent: |
| Cost of one point: |
| Payment at 5 percent: |
| Monthly savings: |
| Break-even point: |
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Keep in mind that if you add the point (or points) to your loan balance, your new payment will be higher than it would be if you paid the point upfront in cash.
Debt consolidation
Homeowners who want to tap equity to pay off other debts, remodel their home or make other purchases face a more complicated decision to refinance, in part because other debts or options such as a home equity line of credit will involve various rates and terms. Debt consolidation may make sense if the refinance would strengthen your overall financial situation and you're disciplined enough not to run up more debts. Debt consolidation can "improve your household cash flow dramatically," Thorne says, and that's an important goal for some homeowners today.
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