During any period of low or falling mortgage rates, opportunities to refinance will present themselves to many borrowers. There are several reasons why homeowners choose to refinance their mortgages, the main objective being to lower their monthly payment.
Yet the refi process isn't always simple or straightforward. To help you decide and prepare for your refinance, we wanted to answer the five most-common refinance questions.
Below are your top 5 mortgage refinance questions answered:
1. Will I benefit from a refinance?
Too many mortgage professionals and personal finance writers make the mistake of using an oversimplified break-even formula to determine how long it takes for monthly savings to offset the cost of a mortgage refinance.
Their calculation is simple (yet flawed): subtract your new payment from the old payment to get your monthly savings, then divide the cost of refinancing by that amount, and voila! You get the number of months it takes to break even.
The problem with this logic is that your reduced payment is also achieved by taking the remaining balance of your original loan and stretching out the repayment period over a new term (say, 30 years). If you have been paying on a 30-year, 6 percent mortgage for five years and refinance the remaining balance over a new 30-year term (at the same rate), your payment goes down. But it's not because of any savings you accrued, it's because you're essentially stretching your 30 year loan out over 35 years.
A better way to realize your true savings is to take a look at HSH.com's "Should you refinance" calculator. It gives you the simple "break-even" calculation so that you know how long it takes to recoup your refinance costs, but it also provides additional information in the "Mortgage Analysis" section that tells you how much you'd pay over the life of your unchanged loan versus what you'd pay if you refinance to current mortgage rates.
This is the best way to determine if a refinance will be beneficial to you.
2. Should I speak to my current mortgage lender about refinancing before shopping around?
Actually, you should probably speak to your current lender after getting refinance quotes from other lenders. Most mortgage lenders have retention programs they use to head off homeowners before they refinance with someone else.
Often, however, the deals they offer are not as good as what you may find by shopping on the open market. In addition, your mortgage lender has less incentive to close your refinance quickly because it already has you as a customer.
Janet Walker of Phoenix, Ariz. did get her current lender to lower her mortgage rate, but not until after they made her work for it. "I called to get my mortgage balance because I wanted to look into refinancing. My lender called me the next day offering to lower my rate. But then they said it would involve a whole application process and paying for an appraisal, and the rate they offered wasn't the best available. I shopped around and told them I'd refinance elsewhere if they couldn't match a better deal that I'd found. They finally did, but it took a while to close the loan."
3. Can I refinance if my home's value has dropped?
That depends. If your current mortgage is a government-backed loan like FHA or VA, you can probably get a streamlined refinance and your home's value will not be a factor. If your mortgage is owned by Fannie Mae or Freddie Mac, you may be able to refinance through the Home Affordable Refinance Program (HARP), even if you owe more than your home's value.
Other options are conventional-to FHA refinancing (allowed up to 97.5 percent LTV), conventional-to-VA refinancing (to 100 percent LTV), or "cash-in" refinancing, in which you pay cash to reduce your mortgage balance when you close on your refinance. If refinancing means adding mortgage insurance or funding fees, be sure to include those amounts in your calculations to make sure that refinancing improves your financial position.
4. Is refinancing for the lowest payment always a bad idea?
Many, many people have made refinancing decisions that they regretted because they based their decision solely on lowering their monthly payment. Ask most people who took out Pay Option ARMs with those tempting 1 percent payments how they feel about them now, and you're likely to get an earful of expletives! But refinancing for a lower payment is a valid choice as long as you know what you are getting into and have plans to deal with the consequences down the road.
If money's tight, and the payment on a 5/1 hybrid ARM gives you the breathing room you need for now, you'll need to determine the possible reset rate in year six and plan accordingly. If refinancing helps you out of a jam now, it's OK that it costs more in the long run as long as you understand that and make the choice willingly.
5. Should I go with a no-cost refinance?
There really is no such thing as a no-cost refinance. Your costs are either rolled into your balance, paid by you, or absorbed by the lender in exchange for you accepting a higher mortgage rate. Not that it's necessarily a bad thing--but if you want the lowest mortgage rate and the best long-term deal, you'll have to pay some fees.
Mortgage Professor Jack Guttentag says that there are several ways to shop for a mortgage. One is to indicate the rate that you want and ask each lender what it would cost. You could look for upfront mortgage brokers (UMBs) which operate by charging an agreed upfront amount and shopping wholesale lenders for the best deal.
Or, you can ask every lender that you deal with to price its loan that way. "A borrower can take the initiative to convert any broker into a UMB. They negotiate a fee, and then the broker finds the best deal available," says Guttentag. You can ask several lenders what their best mortgage rates are for the amount you wish to pay. Get Good Faith Estimates in writing and go with the lender offering the best terms.