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To Refi...or Not to Refi...That is the Question. What You Should Know

Getting a new mortgage to replace your current one is what’s known as refinancing.  This is done so that a borrower can hopefully get a better interest rate and term.  The first loan is paid off, making a new mortgage and discarding the old one.  For borrowers with a good credit history, refinancing can be an effective way to change a variable loan to a fixed, and lower their interest rate. 
In today’s economy, everyone knows how tough making the mortgage payment can be.  If you find yourself in the situation where the belt is already tight enough, it might be time to consider refinancing your mortgage. 
 
BUT, (you knew there was one coming, right?) before moving forward on refinancing your home,take some time and make sure that this is the right decision for you and your family.  No one (at least that I know) has been thrown out on the street for taking a little extra time to consider the pros and cons of one of the biggest financial decisions of their lives. 
 
Without the right knowledge it can actually hurt you to refinance your home. If not done properly, a refinance can increase your current interest rate instead of lowering it.  Sorry folks, it’s not my intention to scare you.  I just want to prepare you for what may happen if you rush into this.  So, at the risk of sounding like a broken record, take your time. 
 
To help you with your decision, below is some information on what exactly refinancing your home means and the risks and rewards that come with it.  Also, you’ll be able to know what steps to take when it comes down to dealing with the process, when to refinance, determine what your actual goal is, and most important, what the costs should look like. 
 
I’m Ready!  But, What is Refinancing?

Okay, so you’ve talked to the family, written down your pros and cons, and after some soul searching, you’ve decided to pull the trigger on refinancing.  First of all, good for you!  It can be a little unsettling, but you’re willing to take the plunge and start on a path of reaching your goal of saving money, so give yourself a little credit! 
But wait…what exactly is refinancing?  It’s the process of getting a new mortgage to lower monthly payments, lower your interest rates, and take cash out of your home for large purchases, or change mortgage lenders or banks. Most people refinance when they have equity on their home, which, simply put, is the difference between the amount owed to the mortgage lender and the value of the home. 
POSITIVE / NEGATIVE EQUITY:  If the amount you owe on the mortgage is say $100,000 and the value of your home is $200,000, then you have positive equity, meaning you owe less than what the home is worth (which is a good thing!).  If you owe more on the mortgage than what your home is worth (for example you owe $200,000 on the mortgage and the home is worth $100,000), then you have negative equity (which is a not so good thing).  Sometimes, you may hear the term “being upside down” being thrown around; that’s what being in negative equity means.  Now you’ll know what someone’s talking about the next time they throw around some mortgage jargon (which I personally hate by the way). 
Okay folks, a little of my own editorial here.  When I talk to real estate agents and loan officers, I think that some of them have to throw these terms around to their clients to make themselves feel smarter.  As I heard a co-worker say to an old boss once, “Your voice would carry much better if you spoke across to people, instead of down to them.”  Sorry to get away from the point here, but a word of advice: just because you don’t know as much as a loan officer or a realtor doesn’t make you any less experienced than they are, just because they’re throwing around terms you may not understand. 

Refinancing:  Pros and Cons

PRO: One of the main advantages of refinancing (equity notwithstanding) is lowering an interest rate. A lower interest rate can have a profound effect on monthly payments, potentially saving you hundreds, and in some cases, thousands of dollars a year.
PRO: Second, a lot of people refinance in order to get money to buy a new car for the family or to reduce credit card debt. The way they do this is by refinancing for the purpose of taking equity (value, see above) out of the home. A home equity line of credit (or HELOC for short) is a tool that serves this purpose.  It’s calculated like this: First, the home is appraised. Second, the lender determines how much of a percentage of that appraisal they’re willing to loan. Finally, the balance owed on the original mortgage is subtracted. After that money is used to pay off the original mortgage, and the remaining balance is loaned to the homeowner. Many people fix up their home after they buy it. 
Depending on what kind of renovations are done, this may raise the home’s value.  By doing this while making payments on their mortgage, these people are able to take out large lines of credit as the difference between their appraised home value and their mortgage balance goes up.
 
CON: One of the major risks of refinancing your home comes from possible penalties you may be charged by paying down your mortgage with your home equity line of credit. Here’s where reading the fine print comes in handy kids:  In most mortgage agreements there’s a provision that allows the mortgage company to charge you a fee for paying off your mortgage, and these fees can amount to thousands of dollars. It’s what’s called a pre-payment penalty.  Before closing on your refinance, make sure it covers the penalty and is still worth it.
CON: Bear in mind that there are other fees to be aware of before refinancing. These costs include paying for an attorney to handle the paperwork and make sure you are getting the most beneficial deal possible, and bank fees. To counteract these bank fees, like the Smokey Robinson song goes, you better shop around or wait for low fee refinancing. Consider the amount of money you may be getting from your new line of credit as well as the amount that you will be saving in the long run; these things are always worth taking a look at.  Do the homework and make sure the end result is the best for you and your family.

What Do I Do To Refinance?

The first thing to do when considering refinancing is to think about how you will pay the loan back. If the HELOC will be used for home renovations in order to increase the house value, depending on the kind of renovations, you may think about it as increased revenue if you ever sell the home as a way to repay the loan. On the other hand, if the credit is going to be used for buying a new car, putting the kids through college, or to pay down credit card debt, it’s best to sit down, break out pen, paper and the calculator to figure out exactly how you will repay the loan to fit into your budget.
Second, you’ll definitely want call your mortgage company and talk about available options, and then compare those with the options being offered by other mortgage companies.  It may be that there is not a current deal which can be met through refinancing that would benefit you. That’s still a good thing, because at least you now have a plan in place so that when the opportunity is right, you can seize it.  It’s like double dutch.  You just have to wait for the right time to jump in. When refinancing, it may also benefit you to hire an attorney to translate some of the more complex paperwork, so long as it’s cost effective.

When Can I Refinance My Home?

Most banks and lenders usually require borrowers to keep paying on their original mortgage for at least 12 months before they can refinance. However, each lender’s terms and programs are different. Check with your specific lender for all restrictions and details.
People have told me that in most cases, it makes the most sense to refinance with the original lender, but it’s not required. Although it may be easier to keep a customer than to make a new one (many lenders don’t require a new title search, appraisal, etc.), with so many lenders available thanks to modern advertising and the Internet, a lot of them will offer a better price to borrowers looking to refinance. Keep in mind that there are services such as RateGator.com that can help you not only find the right lender, but whose mortgage auctions make loan officers compete to give borrowers the lowest rates.
Below are a few key reasons why borrowers may consider refinancing their home.  See which one fits you best:

·         A Lower Monthly Payment. To lower your interest rate and your payment, it may make sense to pay a point or two, if you plan on living in your home for the next several years. In the long run, the cost of mortgage financing will be paid for by the savings you gain each month.  But, if you’re planning on moving to a new home at some point, chances are you won’t be in the home long enough to recover from a refinance and the costs that go along with it.  So, it’s important to calculate a break-even point, which will help you determine whether or not a refinance would make sense. Go to a Fixed Rate Mortgage from an Adjustable Rate Mortgage. For borrowers who are willing to risk an increase in the market, ARMs, (Adjustable Rate Mortgages) can give you a lower monthly payment at first. They’re also ideal for those who do not plan to own their home for more than a few years. Borrowers who plan to make their home permanent may want to switch from an adjustable rate to a 30, 15, or 10-year fixed rate mortgage, or FRM. ARM interest rates may be lower, but with an FRM, borrowers will have the confidence and peace of mind knowing exactly what their payment will be every month for the whole term of the loan.
 
·         Avoid Balloon Payments. Balloon programs, like ARMs are a good idea for lowering initial monthly payments and rates. But, at the end of the fixed rate term, which is usually 5 or 7 years, if a borrower still owns his or her property, then the entire mortgage balance would be due. In this case, borrowers can switch over into a new fixed rate mortgage.
 
·         Drive out Private Mortgage Insurance (PMI). Low or zero down payment options can help buyers purchase a home with less than a 20% down payment. Unfortunately, these programs usually require private mortgage insurance (or PMI for short). PMI is set up to protect lenders from borrowers who are at risk of defaulting on their mortgage. As the balance on a home lowers over time - and the value of the home goes up - borrowers may be able to cancel their PMI with a mortgage refinance loan. The lender will decide when PMI can be removed.

·         Cash out a portion of the home's equity (a/k/a value). Usually, most homes will rise in value, and can be a resource for extra income. Increased value gives the opportunity to put some of that cash to good use, be it buying vacation or investment property, buying a new car, paying for college, home improvements, paying off credit cards, or simply taking a much needed vacation. These are what’s known as cash-out refinances, and may also be tax deductible.  Make sure to have a plan for what you want to do with the cash.

What are the Costs?

Generally, refinancing includes the following closing costs:
 
·         Application fee. Lenders charge this fee to cover the cost of checking a borrower’s credit report and the initial cost of processing the loan.
 
·         Title insurance and title search. This charge covers the cost of a policy, which is usually issued by the title insurance company, and insures the policy holder for a specific amount, covering any loss caused by issues found in the property's title. It also covers the cost to reviewing public records to verify ownership of the property.  Simply put, title insurance and the search make sure that you’re the rightful owner in case someone tries to put a claim on your home.  Sounds crazy, I know, but it’s been known to happen. 
 
·         Lender's attorney review fees. The company or lawyer who conducts the closing will charge you for their services. Closings are done by attorneys representing the buyer and seller, real estate brokers, escrow companies, title insurance companies and even lenders. Borrowers may also have to pay for other legal fees and services related to their loan. They may want to hire their own attorney to represent them in their closing and all other stages of the transaction; this is an option worth looking into.
 
·         Points and fees incurred in loan origination. Lenders charge an origination fee for their work in preparing, evaluating, and processing a mortgage loan. Points are prepaid financial fees which are charged by the lender at closing. This is to raise the lender’s yield beyond the agreed upon interest rate on the mortgage note. One point is equal to one percent of the actual loan amount.  Make sure that all the fees agreed on by the lender are properly disclosed to you. 
 
·         What’s in this for me?  Remember, you have the right to ask all the questions necessary to make sure the lender and the loan officer are doing their job, which is looking out for your best interest!  Keep in mind that with all of this, you’re not financing a toaster.  This is your home and your future.  A lot to put on your shoulders, I know.  But you’ve worked hard to get your home, stands to reason you deserve the best to not only keep what you’ve earned, but to do a little better, right?