Refinancing is the process of replacing your existing loan with a new loan that provides you with some added benefit. There are many ways to benefit from refinancing. You could reduce your monthly mortgage payment by refinancing into a lower rate. You could combine your first mortgage and your home equity line of credit into a single loan with a fixed rate that could provide more long-term security and lower your payments. You could consolidate debts, like credit cards, into your mortgage to lower your payments and possibly be tax deductible (consult your tax professional). You could get cash for home improvement. You could lower your payments by getting rid of monthly mortgage insurance (PMI). You could pay your home office faster. Here are some examples:
Scenario 1 - You have a 3.500% rate with 27 years left on your current loan and your current principal and interest mortgage payment is $1571.66. Your current loan balance is $350,000. You refinance down to a 2.750% rate and the loan costs are $1800.00. The new loan rate lowers your principal and interest payment down to $1436.19. This refinance drops your mortgage payment by $135.47 per month. Does it make sense to refinance into this new loan? Divide the $1800 in closing costs by the $135.47 monthly savings ($1800 / $135.47 = 14). In other words, the $135.47 monthly savings pays for the $1800.00 in closing costs in 14 months. This loan makes sense if you plan to live in the home for at least 14 more months.
Scenario 2 - You have a 3.500% rate with 27 years left on your current loan and your current principal and interest mortgage payment is $1571.66. Your current loan balance is $350,000. Your minimum credit card payments total $610.00 per month and your credit card balances total $22,500.00. You have been paying on these credit cards for years and the balances do not seem to come down at all. So, you refinance down to a 3.375% rate with closing costs of $2600.00. You add the $2600.00 in closing costs to the new loan; you also add the $22,500.00 in credit card debt to the new loan. Your new loan balance is $375,100 and your new principal and interest payment is $1658.30. Your current principal and interest payment of $1571.66 plus your current credit card minimum payments of $610.00 total $2181.66. The new loan drops your monthly payments by $523.36 and turns the compound interest of the credit cards into the simple interest of a mortgage. You also might be eligible for an additional tax write-off – Consult your tax professional.
Scenario 3 - The principal and interest payment on your current FHA loan is $1762.59, and your FHA Mortgage Insurance Premium is $298.00, totaling $2060.59 per month. Your current FHA rate is 3.25%. You refinance your current FHA loan into a 30-year fixed conventional loan at 3.375% with no closing costs. The payment on your new conventional loan is $1801.54. This drops your payment by $259.05 per month. Notice that the new conventional loan has a slightly higher rate, but the payment is still lower than the FHA loan. This is because the conventional loan has no mortgage insurance.
Scenario 4 – Your current principal and interest payment is $1796.18 based on your interest rate of 3.500% and your loan of $400,000. You need $8000 for a new furnace, and you do not qualify for a Home Equity Line of Credit (HELOC). You were considering refinancing anyway because you wanted to lower your monthly payment and you have enough equity to get $8000.00 cash out. You refinance into a 3.125% rate with $1100 in closing fees. Your new principal and interest payment is $1756.34 so, you get the $8000 cash for your new furnace and lower your monthly payment by $39.84.
Scenario 5 - You need $120,000 to remodel your house. You have enough equity to take out a Home Equity Line of Credit (HELOC), but you discover that the HELOC has an adjustable rate; you not only worry about what the rate will be after the initial “teaser” rate for the HELOC is over, but also what will happen when the adjustable rate increases. There is a fixed HELOC available, but the rate is too high – as with many fixed HELOCs. You end up choosing a cash-out refinance because you can get the $120,000 in one loan with a low, fixed rate that will never change.
Scenario 6 – You have 22 years left on your current 30-year fixed rate loan and you have decided to stay this home for life. You are eligible to retire in 13 years and would like the home paid off when you retire. You also discovered that you could save about $55,000 in interest by refinancing into a 15-year fixed rate loan. You realize that you and your spouse can easily afford a 15-year loan payment. By refinancing into a 15-year loan, you will have only two years left on your mortgage when you retire and an extra $55,000 in the bank.
Scenario 7 – You currently have a 30-year fixed conventional loan with a balance of $470,000 and your home is valued at about $522,000. Your current rate is 3.625% and your monthly principal and interest payment is $2266.57, based on your original loan amount of $497,000. You also pay private mortgage insurance (PMI) of $289.00 per month. You have never used my VA loan benefit so, you decide to refinance into a 30-year fixed VA loan at 3.250% with no closing fees, except for the $10,000 VA Funding Fee. You also have $19,000 in credit card debt; the minimum payments on the credit card debt total $530 per month. You decide to refinance the credit card debt into your new VA loan. Your current principal and interest payment, PMI, and credit card payments total $3085.57 per month. The principal and interest payment on your new VA loan is $2180.38, saving you $905.19 per month or $10,800 per year. The savings pay for the VA Funding fee in the first year. NOTE: The VA Funding Fee does not go to the lender. The funding fee goes to the Veterans Administration to help take the burden off of taxpayers and fund the VA loan program for other veterans.
Scenario 8 – I currently have a 30-year fixed FHA loan with a loan balance of $357,000. My principal and interest payment is $1716.37, based off my original loan balance of $365,000. My FHA Monthly Insurance Premium is $287.00, and my rate is 3.875%. I refinance into a conventional loan with Lender Paid Mortgage Insurance (LPMI) at 4.000%. The new principal and interest payment is $1723.47. My new loan saves $279.00 per month even though the new rate is a higher than my last loan. NOTE: Lender Paid Mortgage Insurance is a loan product that offers a slightly higher interest rate in exchange for not having private mortgage insurance (PMI).
You might have heard or read this before: “If you can lower your rate by at least one percent, it’s a good idea to refinance”. That statement is unfounded nonsense that someone made up long ago. There is absolutely no math or reasoning to support it. It makes sense to refinance when there is a benefit for you, as you can see in the examples above. Simple.