Why refinance?
People have all kinds of good reasons to refinance. We'll explain some of the most common reasons to refinance and give you some helpful advice on things to consider.
Lower your monthly payments
Security of a fixed rate loan
Move to an ARM for short-term savings
Take cash out of your home's equity
Eliminate mortgage insurance
Lower your monthly payments
Who doesn't want lower payments? The real question here is whether the cost of the loan is worth the savings. Let's look at an example. Say you have a 30-year fixed rate loan at 9.5% and the current rate for the same loan is 8%—should you refinance for a lower payment?
The old advice was to refinance only if you could lower your home loan interest rate by at least two percentage points. But today there are a variety of other things to consider before you decide.
If you're going to keep the home for just a short time, say two to four years, refinancing with no "out-of-pocket" costs might be a good option. These loans allow you to avoid "out-of-pocket" payment for lender or third-party fees at closing. Instead, you pay a slightly higher interest rate over the life of the loan to cover these costs. Because you'll only pay the higher rate for a short time, the extra interest is less than you would have paid "out of pocket."
But let's say you're thinking of staying in your home at least another few years. Then the most important calculation is the break-even point—how long do you have to make payments at the lower rate before the cost of refinancing has been paid?
 |
|
| Loan amount |
|
$97,960 (originally borrowed $100,000) |
|
$99,960 ($97,960 + $2,000) |
| Closing costs rolled into principal balance |
|
n/a |
|
$2,000 |
| Rate |
|
9.5% |
|
8% |
| Years left to pay |
|
27 |
|
30 |
| Principal/interest payments |
|
$841 ($65 + $776) |
|
$733 ($67 + $666) |
| Monthly equity building |
|
$65 |
|
$67 |
| Monthly increased equity |
|
n/a |
|
$2 ($67 - 65) |
| Break-even estimate |
|
n/a |
|
18.35 months ($2,000 cost divided by $109 in monthly savings) |
NOTE: These sample loans are for illustration purposes only and are not a rate quote, pre-approval, or commitment to lend.
In this example, it makes sense to refinance because you break even in less than 19 months, comparing monthly payments and principal payment based on the amortization schedules. In other words, the savings you achieve in the proposed refinance offset the closing costs in less than two years.
Think you might stay in your home for another five or seven years? The loan to consider here might be a fixed period Adjustable Rate Mortgage (ARM) that starts with a fixed rate and converts to an ARM at the end of the five or seven years. Since you won't be in the home at that point, you'll be out of the loan by then. And you'll have saved a considerable amount on your monthly payments and interest.
With so many ways to lower your monthly payment, how do you pick the right one for your situation? Try our refinance calculator.
NOTE: Relative benefits of the alternatives described above will vary over time and depend on individual circumstances.
 BACK TO TOP
Security of a fixed rate loan
An adjustable rate mortgage is a great way to get into a home with low monthly payments. But the periodic rate adjustments and possibility of rate hikes can be disconcerting, that is why you might want to consider switching to the security of a fixed rate loan. Here again, you have different options for every situation.
Plan to be in your home just for a set number of years? You can get fixed period ARMs that start with fixed rates (from three, five, seven or 10 years for the initial fixed rate term), then the rate adjusts yearly after that. If you stick to your plan, by the time the loan would have converted to an ARM, you'll have already moved. A tip: the shorter the initial fixed rate period, the lower your interest rate.
If you're planning to be in the home for a long time, consider a fixed rate loan with a term of 15, 20, 25 or 30 years. Just remember, fixed rate loans may have a higher rate than what you're currently paying for your ARM. So you want to carefully consider both how long you plan to stay in your home and how important the security of a fixed rate loan is to you.
BACK TO TOP
Move to an ARM for short-term savings
A lot of people might wonder why you would want to go from a fixed rate loan to an ARM. But it can be a smart move if you want to save money on your home loan payments for a year or so before moving to another home.
By switching from a fixed rate loan to an ARM, you can save substantially in the short term. One option is to get a "no out-of-pocket costs" ARM. This will mean a slightly higher interest rate, but since your goal is to save and conserve cash, closing costs are an expense you don't want. You want savings on your payment now.
How much can you save? That depends on your current loan, the ARM you choose and today's rates. Here's an example.
|
|
| Loan balance |
|
$97,960 (originally borrowed $100,000) |
|
$99,960 ($97,960 + $2,000) |
| Closing costs rolled into principal balance |
|
n/a |
|
$2,000 |
| Interest rate |
|
9.5% |
|
6.5% for 1 year |
| Years left to pay |
|
27 |
|
30 |
| Principal/interest payments |
|
$841 ($65 + $776) |
|
$631 ($90 + $541) |
| Monthly payment savings |
|
n/a |
|
$209 |
| Monthly equity building |
|
$65 |
|
$90 |
| Monthly increased equity |
|
n/a |
|
$25 (during first year) |
| Break-even calculation |
|
n/a |
|
8.55 months ($2,000 cost divided by $234 in monthly savings) |
These sample loans are for illustration purposes only and are not a rate quote, pre-approval, or commitment to lend.
In this example, it makes sense to refinance because you break even in less than one year. And if you stick to your plan, you move before the rate adjusts. This demonstrates how an ARM can be a great short- to intermediate-term solution for lowering your monthly payment.
BACK TO TOP
Take cash out of your home's equity
The home loan payment you make each month increases the equity you have in your home. This equity can represent a substantial part of your savings. By refinancing, you can free up some of this money for other purposes. You might need it for a child's college tuition or to invest in a second home.
Another good reason to take cash out of your home is to pay off debts that have non-deductible interest costs. The interest on home loans is, in most cases, tax-deductible. If you have a sizeable amount of debt in non-deductible loans, such as credit cards and car loans, it can make sense to use some of the equity in your home (provided you have enough) to pay off these debts. That way, the interest you pay on your combined debts is now tax-deductible. (See your tax advisor about your particular situation.)
To draw out cash from your home, you can typically borrow up to 75% of the appraised value. At Capital One, we have an expanded cash-out program that allows you to borrow up to 90% of the appraised value of your home.
BACK TO TOP
Eliminate mortgage insurance
Did you purchase your home with less than 20% down? Then you probably have a monthly mortgage insurance payment along with your principal and interest. (Check your home loan statement if you're not sure.)
As you build equity in your home, you eventually reach the point where you have more than 20% equity. You may already be there. In fact, in a favorable housing market where home values are increasing at above average rates, your home's worth may have increased to the point where you have 20% equity simply because your home has become more valuable. But you may not be able to cancel your mortgage insurance yet.
Your goal for this kind of refinance should be to get a loan without monthly mortgage insurance that has a rate as low or an even lower than your current loan. The ideal situation would be to reduce your rate by more than just the cost of your monthly mortgage insurance payment alone.
BACK TO TOP
|
