Should I Refinance My Mortgage?

In the current Real Estate Market, Here are factors to consider when Refinancing your Home: Property Value, Mortgage Rates, and the Cost/Benefit factor.

Property Value: Currently, property values are soaring in many major cities influenced by the Covid-19 pandemic. To take advantage of the value your home has gained, the most popular way is to refinance.  The value of your home may have increased significantly since you bought your property. This could be because of improvements you made to your property or the land value may have increased due to the real estate market demand.

The Covid-19 crisis created a shortage of sellers on the market which caused property prices to increase dramatically simply due to Supply and Demand. When this happens, you can negotiate a new loan based on the new market value of your home. With A refinance, the terms of your current loan changes. In fact, you will get a new loan altogether, perhaps a new interest rate, and there will be a settlement.  That settlement cancels (pays off) your existing mortgage agreement and issues a new one. 

Mortgage Rate of your original Loan vs. New Rates

You must consider interest rates at the time of refinancing. Interest rates directly affect the amount of your monthly mortgage payment. Interest rates change daily due to the condition of the economy.  The current federal interest rates may be better or worse than when you originally obtained your mortgage.  Interest rates were relaxed dramatically to attract more home buyers during the Covid-19 Pandemic.  However, this is changing quickly as the economy deals with inflation and seeks to recover from the pandemic. Many homeowners may have drawbacks to refinancing simply because it resets the number of months/years they have to pay back on their loan. However, taking advantage of a lowered interest rate could dramatically reduce your mortgage payment and give you more leisure with your finances to handle other obligations in the short term.

Types of Refinance Loans

Next, if you currently own more than 20% of your home, you could get what’s called a second mortgage or Home Equity Loan. (Owning 20% means that your loan represents 80% or lower of the value of your home.  Example: House is worth $100k… Mortgage loan is at $80k… You have 20% Equity). Home equity loans allow you to borrow a specific amount from your equity which will be paid back over a set amount of time.  

A second mortgage can be in addition to your current mortgage or if your balance is low enough, they may offer to pay-off your existing mortgage.   However, with a second mortgage, you run the risk of having two payments due per month… that being your initial mortgage (1st lien) and the home equity loan (2nd lien). With Home Equity loans, payments are fixed (principal and interest) for a definite period of time of your choice.

The other type of equity loan is the Home Equity Line of Credit (Heloc).  The Heloc shares the same attributes of the home equity loans when it comes to being a second mortgage and using it to pay off current liabilities (existing mortgages, credit cards, etc).  However, the major difference in the Heloc is that the loan amount is revolving for half the term.  For example, if you get a 20 year Heloc for 100k at 3.25%. For 10 years, 100k will be available for you to draw and repay. You will pay interest on what you use only… and your available balance replenishes when you pay DOWN the Heloc. Its like using your home as a credit card.

Once your draw period of 10 years end, whatever the balance is at the time will be multiplied by the interest rate and become a fixed mortgage payment for the remaining 10 years. Example, if you have a drawing balance of $90k at that time. The $90k will multiplied by the interest rate and become a fixed monthly mortgage payment. Helocs are popularly used for home improvements and Investment properties. They are useful for the cheap cost of borrowing against a property.

Know the Cost/ Benefits

There are many reasons why one may refinance their mortgage. If you have an FHA loan, one reason would be to get rid of mortgage insurance. Part of the great benefits of purchasing your first home with an FHA loan is that you are only required to put down 3% of the price of the house. However, this means you own less than 3% of your home… which means you are probably paying a Mortgage Insurance payment of $100+ per month included in your monthly mortgage payment (Check Your Escrow Statement). 

Mortgage insurance premiums are paid through your monthly payment as protection FOR THE BANK ONLY in case you default on your mortgage. Mortgage insurance is insurance for the bank…not you or your property (that’s homeowners insurance…read Homeowners: 5 Ways to Reduce Your Mortgage Payment). If you own less than 20% of your home, you probably are paying mortgage insurance. However, there is a way out.  Remember the property values?  If the Property values have increased in your area…You may, in fact, own a greater percentage.  You could then refinance to a Conventional loan without Mortgage Insurance.

Let’s Explain this. LTV-Loan to value compares the amount of your remaining principal balance of your loan to the value of your house.  For example, Let’s say the price of your home was $100,000.  You used FHA funding and only put down $3,000.  $100,000 home -$3,000 (Down Payment)= 97,000 Mortgage. Your loan value is $97,000 to the value of $100,000= 97% (97,000 divided by 100,000).  (For all of the geeks…my numbers are rounded for simplistic understanding)

In order to get rid of Mortgage Insurance you must get your loan to equal 80% of the value your home. Here’s How. Let’s Say you know houses in your area are now going for $120,000.

$97,000 (your loan) divided by $120,000 (New Value) = 80%.  How do you prove to your bank that Your housing value has changed? Get an appraisal by your bank/mortgage company. Banks will order an appraisal for a fee ($300-500).  They come out and evaluate your house based on features in comparison to those around you.  Once they appraise your property for the higher price proving equity near 80%… You are clear to refinance. Mortgage insurance…Gone.

Ultimately you may refinance to get a better rate…which equals a lower payment.  Perhaps you closed on a loan with a lower credit score than you currently have.  FHA only requires a 580-620 Credit Score.  After paying on-time for a year, your score is bound to increase which qualifies you for a better interest rate.  Maybe you closed on your home when rates were high.  You may want to free up some cash monthly for other things you have going on.

Investment Property Funding

Another reason to refinance a property is to invest in more real estate. Perhaps the value of your property has gone up so much, its enough that you can actually get cash back.  This is called a “cash out” refinance. For example, Take our $100,000 Home. Let’s say you got your property appraised and property values have soared up to 160,000 in your neighborhood. 

$97,000 loan divided by $160,000= 60% LTV.  You Could borrow an additional 20% in cash and still be at 80% LTV. 20% of $160,000= $32,000 cash.  Maybe you can use that to renovate your home.  You could even use it to invest in MORE real estate.

Know the Purpose and the Cost

Here are the costs you must evaluate.  When Refinancing a mortgage, you are essentially RE-buying your home all over again.  This means there will be closing costs.  Most banks offer incentives for refinancing back with them for a better rate. These are called streamline refinances.  Closing with a new bank could be more expensive but if the benefits are right… take it.  Closing costs can range from $10-20k.   You have to evaluate your needs and your savings over time.  A $5000 closing could save you $40,000 in Mortgage insurance.  Contrarily, paying a higher interest rate on a cash out refinance could yield you a FIX and FLIP in which you profit $100K.

These are just a few reasons to consider a refinance… There are many others! If interested in doing a refinance, you should shop around with banks to find the best rate… for an in depth analysis of your specific circumstance contact The InvestorSmith for help.