With the recent Fed decisions to lower rates, the opportunity to refinance has perhaps never been greater. There are a number of reasons to consider refinancing the loan on your home.

Some people refinance as a way of taking advantage of lower interest rates, enabling them to reduce their monthly mortgage payment. Some refinance to a shorter-term mortgage, which enables them to build equity in their homes faster. And some homeowners refinance to tap into the equity (the appraised value less the balance of your first mortgage) they’ve accumulated in their houses, using the funds for home improvement or other needs, such as debt consolidation or their children’s education.

Do you want to take advantage of these benefits, but wonder if refinancing will be worth the time and money you’ll need to invest? Do you feel unsure about the entire refinancing process?

Generally speaking, the process of refinancing is simple. It involves paying off your existing mortgage loan and taking out a new one on the same house. Your new mortgage loan could be at a more attractive interest rate, or for a different term. Or, you could get an entirely different type of loan — for example, you could switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage.

The traditional refinance rule of thumb, that you must get an interest rate at least 2% below the interest rate you currently have, is often wrong. Why? Waiting for a two percent difference from your rate to show up in the marketplace can actually cost you money. For some people, as little as one-half of one percent can be enough, if all other factors fall into place. In addition, since ARMs are priced at below-market rates, it’s almost always possible to get that 2% spread — though you may or may not want to. The only way to determine whether refinancing is for you is to go about it the right way: by analyzing the time and the cost factors.

What is your time frame? Simply put, it’s how long you plan on holding this mortgage, although it can be more complicated than that. You might have a product that demands refinancing like a balloon mortgage. In this case, your time frame is only until the balloon period runs out. But, if you don’t have to refinance, your time frame can be as long as you plan to stay in the home you’re in. When determining your time factor, it’s crucial to be honest with yourself, since the time factor will determine if and when you begin to save money. It’s a fact that refinancing can cost a considerable amount of money, so you’ll want to be as certain as possible of your time frame. For example, is it likely that your employer will relocate you to another city, or that you’ll change jobs soon? Do you have a physical condition that could require you to move? Evaluating all possibilities is vital, but only you know what your time frame will be.

One other factor involved in refinancing your mortgage: how much money you’ll need or want to borrow. Most lenders will let you borrow around 80% of your home’s current appraised value. Some will allow more, if you’re simply refinancing your existing loan. Refinancing is a wonderful opportunity to
decrease the duration of a payoff, reduce
monthly payments, increase available cash, or
get money from what is probably your largest
asset your home. But, if you’re looking to tap equity, known in the mortgage industry as a cash-out refinance, you’ll probably find that it’s less than 80%. In many cases, cashing-out will mean that you’ll have a larger mortgage balance than before, with possibly a higher monthly payment — and you’ll have to qualify for that new mortgage.

Another consideration with a cash-out refinance is that you might not be able to get that nice low rate you’ve seen, if your mortgage amount will be above the ‘conforming’ loan amount. Conforming loans are sold to large secondary market investors — mostly to Fannie Mae and Freddie Mac. Since they buy so many, the rates are often lower. However, loans above the conforming limit, known as ‘jumbo’ loans, often have interest rates as much as 1/2% higher than conforming, since they are bought and sold on a much smaller scale. This is also known as the ‘jumbo premium’. In short, if you have to or want to take out a jumbo mortgage, be prepared to pay more for it.

If freeing up cash in your home is what you’d like to do, there’s a way to do so, even without refinancing: taking a home-equity loan. Home equity loans can be a viable alternative to a cash-out refinance. Important to remember though, is that they are not without their own set of risks. Most Home Equity loans are of the adjustable-rate, revolving ‘line of credit’ type, and work much like a credit card does, and lenders will generally offer you as much as 75% of the equity in your home. Most lines are pegged to the Prime rate plus a margin, but be careful — most don’t have per-adjustment interest rate caps, and some have lifetime caps of as much as 25%. There are fixed rate home equity loans available too, and they function much like any first or second mortgage does, but will cost you more than a line of credit.

But aside from the monthly payment of interest plus principle, it is imperative to remember that refinancing is not unlike the closing you had when you first bought your home and acquired your mortgage. Closing costs still apply as an out-of-pocket expense for the consumer. While some closing costs are standard, there are some that may be specific to our local market, or to our State. Estimating your costs will take a little research, but it’s important because they’ll cost you anywhere between $1000 to $5000 dollars. Along with the time factor, they will determine your savings or costs when you refinance.

The major closing costs in obtaining a mortgage are known as ‘points,’ or as ‘discount’ or ‘origination’ points. Each point is equivalent to 1% of the mortgage you owe. How many points you want to pay, or whether you want to pay any at all, depends upon how much cash you have available. Typically, paying more ‘discount’ points will lower the available interest rate, since they are a prepayment of interest; however, you may not know that points often can be traded off for a different interest rate — such as 6% and 3 points, 6.125% and 2 points, 6.25% and 1 point, and 6.375% and no points. (This is just an example).

So, if you decide that paying points is not for you, expect to pay an incrementally higher interest rate. Origination points are a different matter, since they technically are a fee, and they have no effect whatsoever on the interest rate you can obtain.

Most people want to recoup their closing costs within a “reasonable” amount of time — typically, three or four years. Of course, lowering your monthly payment (if that’s why you refinanced) will put a few dollars back in your pocket every month. Your break-even point (the point where the savings each month has offset the cost of your refinance) should be short enough that you enjoy at least a year or two of savings after the breakeven point expired.

To start with, you’ll need to know what the available interest rates are on the type of mortgage that fits your needs; the difference between your current and projected monthly payments; and your closing costs. Keeping these criteria in mind will help you make an informed decision about refinancing and the terms which you agree too.

Refinancing is a wonderful opportunity to decrease the duration of a payoff, reduce monthly payments, increase available cash, or get money from what is probably your largest asset — your home. Like home-buying, it can be a powerful tool to increase your wealth. With our current environment, the time may never have been better.

If you’ve decided you might want to consider refinancing, speak to your Realtor or Mortgage Professional. They will be able to help you locate the resources necessary for a sound refinancing decision.