When to refinance your mortgage |
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A prepayment penalty on your mortgage is another reason
to consider delaying a refinancing. The penalty payment creates
another layer of expense. While Bankrate's refinancing calculator
will let you incorporate the cost into the decision to refinance,
if you can wait out the typical two to three years that the prepayment
penalty is in place, you're likely to improve your results when
refinancing. Of course, interest rates could be much higher at the
end of the prepayment penalty period than they are today.
If you're struggling to make your mortgage payment, but can't get a refinance, you may want to try to negotiate a mortgage modification. The Bankrate feature "Borrowers look for mortgage modification" offers more information.
Type of refinancing
If you decide that a refinance is the right move, you'll have to decide what type of new mortgage is right for you. The two major types of refinances are cash-out refinancing and standard "plain vanilla" refinancing, where you are just refinancing the existing mortgage balance.
In a cash-out refinancing, you take out a new mortgage on the same property in which the amount borrowed is greater than the amount of the previous mortgage. The difference is taken out in cash.
Freddie Mac classifies a cash-out refinancing as a new mortgage with a new loan balance at least 5 percent larger than the old loan balance.
A cash-out refinancing will typically have a slightly
higher interest rate than a plain-vanilla refinancing because the
lender has more money at risk. Cash-out refinances often are used
to pay down debt, but this type of mortgage has both pros and cons.
For example, imagine that you use a cash-out refinance to pay off credit card debt. On the pro side, you're reducing the interest rate on the credit card debt and freeing up lines of credit on your credit cards.
On the con side, you may pay thousands more in interest expense because you're taking 30 years to pay off the balance you transferred from your credit card to your mortgage. You also run the risk of running the balances back up on your credit cards and not being able to make the payments.
However, the biggest risk in this scenario is in converting an unsecured debt into a secured debt. If you can't afford your credit card payments, you get nasty calls from debt collectors, a black mark on your credit report and a lower credit score.
Miss a few mortgage payments and you can lose your
home to foreclosure.
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On the other hand, plain-vanilla refinancing is intended
to replace your existing mortgage with a new one at a lower rate.
There's no cash out, unless it's to cover closing costs.
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