Mortgage refinancing costs time and money, so don’t waste either by choosing the wrong loan. Refinancing the smart way means choosing the right loan, then finding the best deal on that loan.
Refinancing: What’s Your Goal?
Your first step is defining what you hope to accomplish when you refinance. Here are some possibilities:
- Lower your interest rate. If rates dropped after you got the mortgage you have, or if your credit has improved from sub-prime or Alt-A to prime, you may qualify for a lower rate. You can also achieve a lower mortgage rate by switching to a loan with a shorter term, such as a 15-year fixed rate mortgage (FRM) or an adjustable rate mortgage (ARM) like the 5/1 hybrid (which has a rate that’s fixed for five years).
- Replace an ARM with a fixed loan for more stability. If you know that you’re going to keep your home for more than a few years, locking in today’s low rates is a smart move.
- Lower your payment. If you need to improve your cash flow, you can achieve that by stretching out your remaining balance over a new term, lowering your interest rate, or both. Keep in mind that this may extend the time it takes to repay your mortgage and it can increase the amount of interest paid.
- Pay your mortgage off faster. You can do this by refinancing to a shorter term, which should also provide a lower interest rate. Or you can refinance to loan with a lower rate and use the money you save to pay down your principal early.
- Convert equity to cash for renovations, investments, debt consolidation or other big-ticket purchases – you can do this with a cash-out refinance, home equity loan or home equity line of credit.
- Convert equity to cash to supplement retirement income – this can be done with traditional home equity financing or a reverse mortgage.
Choosing the Best Refinance Product
Most homeowners’ needs can be met with more than one refinance product. Review what’s available and choose the product best for you.
- If you want to reduce your rate, look into streamline refinance mortgages, which can be faster and cheaper. Streamline refis are especially appropriate for people whose homes have lost value since they got their current mortgage. FHA borrowers can choose streamline refinancing with or without an appraisal. People with VA home loans can apply for Interest Rate Reduction Refinance Loans (IRRRL), and folks with certain Fannie Mae or Freddie Mac loans may be eligible for HARP or Refi Plus refinances.
- The lowest refinance rates are found with shorter term fixed loans like the 15-year FRM or hybrid ARMs, which have rates fixed for 3, 5, 7 or 10 years and are amortized over 30 years.
- If you have a subprime or Alt-A loan now, you should be working to clean up your credit and monitoring your credit score. Anyone refinancing with credit issues should look into FHA or VA mortgages first.
- Stretching your balance over a new term can lower payments even if you don’t drop your mortgage rate. If you replace your 5-year-old 30-year, $300,000 loan at 5.5 percent with a new 30-year loan at the same rate, your payment would drop $128 – and today’s rates are considerably lower than 5.5 percent! If you were to get a rate of 3.75 percent, your new payment would be $419 lower. However, you will have extended your repayment period by five years.
- Shorter mortgage terms, such as 15 years, have a couple of advantages--a lower rate and faster payoff. If this is your objective, refinance only if you can get a lower rate than the one you have. Otherwise you can simply accelerate your mortgage payoff on your own without incurring the expense of refinancing.
- Homeowners who need cash can choose between cash-out refinancing and home equity loans. Cash-out refinancing costs more but carries lower rates. Home equity financing costs less but the rates are higher. Run both scenarios before making a choice.
- Finally, folks 62 and over who want to supplement their income should look into reverse mortgages if they don't have the income or credit scores to qualify for lower-cost financing.
Your mortgage is an important component of your financial portfolio. Consider your decision to refinance as carefully as you would any other investment.