When interest rates fall a lot, refinancing can be an intelligent financial choice. You secure a lower interest rate, to pay less each month, and can potentially get you to the same or another big financial goal in the same or even fewer steps by following the same principles: live within your means, save more than you can, and invest what you save. If you pay less interest, you potentially have more money each month. If you potentially have more money each month, you potentially have more value, which can be attained in several ways. Understanding refinancing can help you determine the total value proposition, and if it is a good financial choice.
When you refinance your mortgage, you get rid of one loan and obtain another in its place. It’s a simple concept with complex mechanics. At its most basic, it’s replacing one “mortgage note” with another. Ideally, you make the shift when interest rates drop and your home’s value rises. Savings result. So does opportunity—the chance to tap into your home’s equity, especially when refinancing is combined with “cash out.”
Refinancing comes with a slew of advantages, and an interesting one about it is that it doesn’t just have one; it has a not-insignificant number of them. But of all refinancing’s benefits, perhaps the key benefit is its ability to give homeowners a way to potentially lower their monthly mortgage costs. You see more of where your money actually goes. When you do, you gain a better foothold over other expenses.
You can also pay off your mortgage sooner by refinancing. When you refinance, you can secure a lower interest rate. With that lower rate in place, you can keep making the same payments you were making before. But the difference this time is that more of your payment is going towards the actual loan amount, reducing the principal. This increases the rate at which you’re paying off the loan.
One more benefit is that this is a chance to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. The statement emphasizes ARMs’ usual characteristic of starting with low rates that tend to increase and lead to higher monthly payments. Replacing an ARM with a fixed-rate mortgage puts home buyers into a situation where their payment does not hike up.
Refinancing your mortgage starts with analyzing your financial position. How are you doing right now, as compared to how you were doing when you first got the loan? (Did you get transferred away from the factory where you used to be a manager? Did you just lose your job, or worse yet, did your spouse lose theirs? Oops. Sorry. That’s the kind of thing that makes economists morose, not you. That and the Cubs never winning the World Series.) At any rate, are you in the financial same ballpark? And if so, what could happen to change that?
After that, examine and contrast proposals from a range of lenders. Mortgage rates, payment terms, and other conditions depend on the lenders themselves and can differ widely. That’s why it’s important to look at a number of different proposals and not limit your selection to just one—at least not without comparing that one to a few more. Significant sums of money are at stake. Think of it as car shopping. If you look around a bit, you can usually find a much better “price.”
When you select a lender, there is still another step you need to complete—an application for the mortgage itself. Just like with your first mortgage, applying for a refinance requires you to provide evidence of your income, assets, and debts (also known as the Debts Outstanding). How much of this condition you must meet is partially determined by the credit score and financial history that you can offer the lender; however, as we covered in Chapter 3, the lender also looks at how these conditions measure up to the times.
After you give a lender information about your home, they will ask for an appraisal on the property to conclude its present market value. This crucial phase establishes the new mortgage amount can be supported by the value of the property. It will also have a hand in the interest rate and loan conditions that can be finalized with the borrower.
Once the appraisal and underwriting processes are over, the lender will provide a closing disclosure. This paper will lay out exactly the terms of the new loan. Really read this over and make sure the contents are what you are expecting. Make sure, once again, that all the terms of the agreement—especially the stuff that wasn’t part of the initial breakdown that I gave you when first talking about refinancing—can be found on this discounted bit of vellum. If not, red flag; go back and make sure.
When contemplating applying for a refinance, one must take into account the expenses tied to the process. These costs are commonly referred to as “closing costs,” and they can swing quite dramatically—usually somewhere between 2% and 5% of the loan amount. You can think of them as similar to the fees one has to pay when applying for a new mortgage in the first place. They’re appraisals, title insurance, and other kinds of real estate settlement services.
To sum up, the process of refinancing your mortgage to obtain a lower interest rate can provide you with some real advantages, including cutting your monthly outlay, letting you rack up less in total interest, and giving you peace of mind. As you work on your decision to refinance, bear these points in mind and remember that they apply with a force that can’t be ignored. Even with the existence of some real financial benefits, however, you have to balance these against the disadvantages of going through the refinancing process to make sure you end up with a net positive at the end of it all.
