The current housing crisis has brought about difficult times for many home owners but it has also produced the lowest interest rates in history. Those who can, are tempted to refinance. But, not all home equity loan refinancing is the same. There are responsible reasons to refinance (such as consolidating debt) and there are irresponsible reasons to refinance too (i.e. the purchase of non-essentials such as boats and vacations). Refinancing for the wrong reason could lead to a much feared foreclosure.
Homework needs to be done before deciding to refinance. Probably the most basic information needed is the interest rate of the potential new loan. The interest rate of the new mortgage should be 2 percentage points lower than the current loan to make a refinance worth while. Also, how long it will take to break even compared to the life of the loan should be considered. All loans involve the payment of closing costs and it usually takes the average person about 3 years to “pay off” those costs. Those who plan to sell the property before the 3 year mark might not find a refinance to be in their best interest.
Loan type and the mitigating factors should be taken into consideration. Variable rate loans, also known as Adjustable-Rate Mortgages (ARM) also have a variable monthly payment amount. Some wish to refinance to a fixed rate mortgage so as to remove the uncertainty from the equation. Another ARM might also be desired, but with the addition of protective features such as lower starting rates and payment caps.
The mortgage term is also important. If a property owner wants fast equity growth, then a short term loan would be the best option. Long term loans are usually the better choice when the refinance is needed to pay for a college education or to buy home improvements using the equity in the property.
Not all mortgages are “refinance friendly.” In fact, some assess fines against the property owner for early pay off. The current home loan agreement should be read carefully to determine if these fines apply. Sometimes the fines are so expensive that the savings from a refinance isn’t enough to warrant a change.
Once a home owner decides to refinance, he or she needs to then decide what type of mortgage is the right fit. The annual-percentage-rate (APR) and the loan type (variable or fixed) should factor into the decision as well as other items such as the life of the mortgage. Short term mortgages have a high monthly payment but a lower interest rate.
Origination or discount fees (also known as “points”) re fees payable to the lender at the time of closing and one point represents one percent of the mortgage’s value. In recent years, many mortgage companies have been offering the “no-cost loan” (zero points), but these loans have many serious pitfalls that can turn out to be quite expensive (and risky). The amount in fees, or points, balanced against the lowered interest rate should be factored into any refinance calculation.
Refinancing can be done in two different ways. The “cash out” refinance is when the original mortgage is refinanced for a larger amount than the balance owed. This guarantees that the home owner will be handed cash at the time of signing. The home equity loan does not touch the original mortgage at all. It is actually a second mortgage based on the equity in the home.
Deciding which type of refinance to use should be based on 4 factors: term, rate, cost, and speed. Home equity loans are faster to obtain, are shorter in term, and are quite flexible. Their major drawback is that they tend to have a high interest rate. Whatever the choice, it is important to research all options before making a final decision.