Mortgage rates has recently reached levels we haven't seen in many years, so you might want to start thinking about refinancing your mortgage. There are many factors you should take into account: current mortgage amount, current monthly payment, current rate, term and type of your mortgage and your plans to stay in your home in the future, the costs associated with refinancing, your current property value, and your credit score.
There are four major reasons people do refinancing:
1) To lower monthly mortgage payments (please note that the refinancing won't change the amounts you owe for city and school taxes and for your home insurance).
2) To save money in the long run by paying off the mortgage sooner (say, in 15 years instead of 20 years)
3) Get cash (consider this only if you are really strapped for money)
4) To change mortgage type (for example, people with adjustable mortgage rates may switch to a fixed-rate mortgage so they should not worry about their rate going up in the future).
Closing costs associated with refinancing (make sure you get a good faith estimate of these costs BEFORE you sign any papers):
Lender Fees - Origination, Application, Transfer, Processing fees and so on. The amounts vary greatly depending on the mortgage company.
Third party costs - the costs you pay to a third party (not your mortgage company) at the time of closing. These include Title Insurance, Closing Fee, Appraisal, Notary services, Courier and Credit Report fees, Recording Fee etc.
Points - a point is 1% of your loan amount (say $2,000 if you loan amount is $200,000). Usually you can buy up to 3 points thus decreasing your interest rate.
Usually, closing costs range from 2.5% to 3.5% of the loan amount.
Here's couple of refinancing scenarios for hypothetical Family A:
Bought their house 10 years ago
Original loan amount: $300,000
Original Term: 30 Years fixed
Original Rate: 5.9%
Monthly payment (excluding taxes and home insurance): $1,779
Left to pay: $250,000
Scenario 1. Do nothing (continue with current mortgage).
In the next 20 years Family A will pay $175,400 in interest on top of principal balance of $250,000 (total amount to pay: $425,400).
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Scenario 2. Refinance to lower monthly payment (they have some extra money now but they expect their income to decrease in the future so they want to decrease their monthly payments from $1,779 to about $1,600).
They refinance as follows:
Total closing costs paid at the time of refinance: $6,200
New loan amount: $250,000
New Term: 20 Years fixed
New Rate: 4.79%
New Monthly payment: $1,621
In the next 20 years Family A will pay $139,000 in interest on top of principal balance of $250,000 (total amount to pay: $389,000).
Benefit: Family A will save $30,200 ($36,400 in interest savings less $6,200 in upfront costs) in 20 years compared to scenario 1 (well, in reality you have also consider tax consequences because the interest is usually tax deductible; the actual savings could be lower than $30,200). Also, they will be paying $158 less per month ($1,896 less per year), so if they stay in their house for 3 years and 4 months they will recover their refinancing expenses.
Downside: They need to pay $6,200 upfront.
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Scenario 3. Refinance to pay off their mortgage sooner (they know their income will allow to make higher monthly payments in order to pay off the mortgage in 15 years instead of 20).
They refinance as follows:
Total closing costs paid at the time of refinance: $6,050
New loan amount: $250,000
New Term: 15 Years fixed
New Rate: 4.58%
New Monthly payment: $1,923
In the next 20 years Family A will pay $96,100 in interest on top of principal balance of $250,000 (total amount to pay: $346,100).
Benefit: Family A will save $73,250 ($79,300 in interest savings less $6,050 in upfront costs) in 15 years compared to scenario 1 (again, the actual savings will be probably lower due to tax implications).
Downside: They need to pay $6,050 upfront and pay $144 more per month.
Refinancing Tips
1. You should not refinance if your current mortgage amount is relatively low (say, $50,000 or less) or you have only couple of years left before your mortgage is paid off or you are not planning to stay in your house for at least three years.
2. Remember that all the rates you will see while shopping for refinance assume you have an excellent credit score. If this is not the case be prepared to see a rate that is higher than the advertised one.
3. You should consider refinancing if the interest rate for current program is at least 0.5% lower than your original mortgage rate (compare same mortgage type and length with same points, etc).
For example, if you 30 Yr fixed-rate mortgage had a rate of 5.9% then current rate for the same type of mortgage should be 5.4% or lower - chances are you'll be able to find a program that will be beneficial to you.
4. If you don't have enough money to pay the upfront costs consider No-Cost Mortgages where you would not pay upfront costs - of course the lender will recover their costs by increasing the interest rate, however this still may be a good option for you if your current rate is high.
5. Check with your current mortgage company - they may eek out a good refinance deal to keep you their customer.
6. Make sure your current loan does not have a provision for a pre-payment penalty, this may affect your decision to refinance.
7. Points you pay at the time of refinancing are usually tax-deductible (check with your tax advisor).
8. Here's couple of sites where you can get and compare current mortgage rates and terms: Amerisave, The Money Store, Bankrate.
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