About Refinancing a Home
- When homeowners refinance their home, they cancel their existing mortgage and take out a new one. As with the initial mortgage, there are a number of closing costs associated with refinancing. A homeowner may choose to refinance with the current lender or a new one, though it may be more advantageous to stay with the existing lender. In addition, depending on when you took out your mortgage, you may be limited on how soon you can refinance.
- The best time to refinance is when you can prove that it will be financially advantageous to do so. Simply calculate your new rate to determine your savings and then deduct the new closing costs. If you will still save money, it's probably a good idea to refinance. Some general rules on when you should refinance are if your current interest rate is a variable one (and you will be switching to a fixed rate), you intend to remain in your home for at least three years, the new interest rate is at least 1 percent lower and you can recoup the closing costs within 12 to 16 months. In addition, if you have recently gotten a significant boost in your credit rating or some particularly bad credit dropped from your history, you may want to see if you now qualify for a better rate.
- Your current mortgage may be subject to a prepayment penalty, which is a fee you must pay if you decide to refinance during the penalty period. This penalty period may last for six months to five years and be as much as 3 percent of the total mortgage. A prepayment penalty may negate the financial benefits of refinancing. Refer to your contract if you are unsure. In addition, refinancing early in your mortgage means you may not have built up much equity. Generally, you will need 5 to 15 percent equity in your home before a lender will consider refinancing your loan.
- Refinancing fees may comprise 2 to 6 percent of the total mortgage. They may include the application fees, title search and title insurance fees, the lender's attorney's review fees, loan origination fees and appraisal fees. You may be able to get your existing lender to waive some of these fees, particularly if the current mortgage is less than five years old, since this lender is familiar with your credit history and the details of your home. If your current mortgage is fairly new, ask your lender for a reissue rate, which may lower your title fees by 50 percent.
- A lender may require you to put aside money for your property taxes and home insurance in an escrow account. This is to protect both you and the lender, since failure to pay these financial obligations when due could result in having a lien put on your home. While having an escrow account will increase your upfront closing costs, it will also lower your interest rate. In addition, allowing the lender the right to pay these fees on your behalf means that you won't have to worry about remembering these obligations. The disadvantage is that the lender earns interest on the escrow account. Had you held the money in your own account, you would have earned the interest. You may be able to forego an escrow account by putting at least 20 percent down at closing.
- Avoid no-cost or no-fee refinancing, unless you intend to pay your mortgage off quickly. This type of refinancing boasts minimal or no upfront fees. In reality, however, those fees may be spread over the life of the loan, which means you'll pay interest on them. Pay closing costs upfront. In addition, opt for the shortest mortgage that you can afford. This will reduce the amount of interest you'll pay on the loan. Be careful when opting for cash-out refinancing. It may be financially advantageous to take out some other type of loan.