One of the most commonly asked questions among homeowners is, “When is the best time for mortgage refinancing?” There was a time when borrowers refinanced when interest rates fell by two mortgage points, but that is no longer the standard in today’s mortgage refinancing marketplace.
Now a mortgage refinancing can be completed quickly at just about any time, and it no longer takes a large outlay of cash to refinance.
In June 2003, mortgage refinancing rates fell to their lowest in years, an incredible 5.21% according to Freddie Mac. In 2006, the rates were approximately 1.25% higher, which made a large difference in monthly payment amounts.
It isn’t hard to see why you would refinance a mortgage when the rates are falling, but what about mortgage refinancing when the rates are rising? Why refinance then?
Here’s how it works. Some homeowners should refinance their entire mortgage loan, some should only refinance a portion of their loan, and some borrowers should not refinance at all. The key is to know which option is best suited for your particular circumstances.
If you refinanced with a fixed-rate mortgage loan in 2003, you want to keep that loan as long as it is practical to do so. There are times, however, when even a borrower with a great rate loan should consider their mortgage refinancing options.
Cashing Out Your Equity
According to the NAR (National Association of Realtors), the average home cost in 2003 was approximately $165,400. In 2006, the same home increased to a worth of around $211,000. That’s an increase in value of $45,600.
The increase in home value is indicative of two things.
1) If you want to refinance your mortgage loan, you most likely have much more home equity than you did before the increase in the property value.
2) The increase in equity means you can get cash from your equity without affecting your current mortgage loan, which is a great option if you have a low rate loan you don’t want to change.
Let’s imagine that the 2003 home was bought with 5% cash down. This equates to a $165,400 home financed with $8,270 down payment and a first mortgage of $157,130. With a 5.5% interest rate, in two years the mortgage loan balance is reduced to $152,585. The same property increases in value to $211,000, bringing the available equity to $58,415.
You could take out a new loan for $211,000 to get the cash out of the house. However, that would mean mortgage refinancing for $211,000, paying off the old loan with the 5.5% interest rate, and getting a new loan with a higher interest rate. This would not be a wise move.
A much better alternative would be to get a second fixed rate loan or an equity line of credit, which typically comes with a variable interest rate. The first low rate loan remains in place. The second mortgage loan allows you to keep the initial loan and obtain cash.
Second mortgage loans often require little if any out of pocket cash. This doesn’t mean the loans are free; what usually happens is the lender pays some or all of the loan closing costs.
Because the lender offers some help with the closing costs, the loan usually has a slightly higher rate. Also, loans that don’t require much cash up front usually have a hefty pre-payment penalty. This means if you refinance the loan within a couple of years, a penalty might be due. Your lender can provide all the specifics regarding your particular mortgage refinancing loan.
Protecting Your Future
You may currently have a low interest rate loan with a manageable monthly payment for now. However, if you have a flexible ARM or a loan that converts from a fixed rate to an ARM after a few years, you might want to plan ahead to avoid a sudden increase in payment.
A 5/1 adjustable rate mortgage might have made it possible for you to purchase a property that has since increased in value and could not be financed with a fixed rate mortgage at the time it was purchased. By utilizing the 5/1 ARM option and purchasing a home that increased in value in a short time, your net worth is dramatically increased.
However, the loan that made it possible for you to purchase the property at the time can quickly become quite expensive if the interest rates go up. In that situation, your smartest move is mortgage refinancing to a fixed rate loan to avoid a dramatic increase in your monthly payments and a higher cost loan overall.
Think about a $300,000 two step 30 year adjustable rate mortgage made a few years back. The loan has a 5.5% initial interest rate that remains effective five years into the loan. After that, the mortgage converts into an ARM for the remainder of the loan period of 25 years.
The monthly payment for this loan in the initial five years is $1,703, including principal and interest. In the sixth year, the rate increases to 6.5% and the loan balance decreases to $276,949. This brings the new monthly payment to $1,870.
The higher monthly payment may not be a problem for you depending on whether your income has increased over the initial five year period and the interest rate at the time the loan converts. If the rate goes higher than 6.5% and is at 7.5%, the payment will be $2,047. This is before insurance and property taxes are figured in.
Similar to a new automobile, a mortgage loan is attractive and bright when new but the loan can become outdated quickly. Just because a loan works well based on the economics of the time doesn’t mean it always will. It is important to evaluate mortgage loans on a regular basis to determine if mortgage refinancing is a sensible solution for you.