When thinking about refinancing, I have two main rules to go by:
• You want to lower your interest rate by a minimum of 1.5% and/or
• You want to lessen the time remaining to pay off your mortgage and own your home outright.
While each situation is different and lengthy advice cannot be offered, it is meant as a guideline for further discussion with your trusted advisors to see how and when refinancing may be appropriate for you.
Let’s tackle interest rates first. In the past 5 years or so, we have seen interest rates decline in a steady downward direction, going from 7% or so to the current 4%, depending on the type and length of the mortgage, which can also be affected by your credit rating. If your current mortgage is a 30 year conventional and your current rate is 5.5%, the goal would be to reduce your interest rate to 4%. Additionally, if you can reduce the number of years to pay, you’ve got a double bonus- and that’s the ultimate goal.
There are a plethora of mortgage options available to you- 30 year conventional, 15 year conventional, Adjustable Rate Mortgages (ARM), Bi-Weekly- and a host of variations invented by the banks and lenders. Let’s look at the basics:
Both the 30 and 15 year conventional work the same way: with a fixed interest rate for the term of the mortgage, you get the same payment every month. The only thing that varies is the time you pay. With the 30 year, your payments will be less, but your overall payout over the 30 years will be substantially more than the 15 year conventional- but again, the monthly payment will be less. Interest rates may be more than an ARM, but it offers stability of rate and payment amount.
The ARM comes in a variety of timeframes: a 3/1 means your interest rate is locked in for the first 3 years, of which then it will adjust to a pre-determined factor (1 year treasuries, a libor rate, prime plus a few points, etc). It may be 3/1, 5/1, or any variation of timeframes. Interest rates will vary over the life of the loan, which may work for you (lower rate at renewal) or against you (higher rate at renewal. Changes may involve rates, amounts, terms and principal balance due, depending on the terms of the loan. Be aware that the opening rate is usually low, and can be construed as a “teaser rate” to bring you in, but depending on the interest rate cycle, may work against you at renewal.
A home Equity Line of Credit is a line of credit using your house as collateral. While it may seem a good way to access cash, be aware that the HE loan is usually a variable rate, and may strap you when interest rates go up and you can’t pay it off.
Our goal is get all of our clients to live debt free. Don’t take out any additional money at refinancing if you can help it- it will cost you more monthly, and reduce the equity you have in your home. Never roll you credit card debt into your refinance- essentially it means you will paying off that card for 15 or 30 years, and you will pay, with interest, 3-5 times your debt with interest. You will be paying for that couch long after it’s been threadbare and gone.
While there are a vast variety of other options (graduated payment, balloon, interest only) the above are the most commonly used. It is crucial that you tread on this issue with caution, use your advisors wisely, and take your time before settling on your new mortgage. Be sure to think ahead: today’s panacea may be your renewal nightmare.