Actionable Mortgage Refinance Techniques You Can Use Right Now

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I think you’ll agree with me when I say:

Mortgage refinancing is a tactic which enables homeowners to get lower interest rates, take cash out of their current home or change their rate and term of the mortgage.

Home refinancing is a huge financial decision to make.

It gets better:

You should be careful in going about the whole process. In refinancing, your new lender will cover your mortgage and will replace it with a new one.

Most of the homeowners do refinancing to cut down their monthly expense, but there are also some who refinance from a 30-year mortgage term to a 15-year term. Doing this could enable them to pay off their mortgage term quicker.

Remember that refinancing isn’t exactly the same as second mortgage. Second mortgages give you funds out from your home equity. On the other hand, refinancing offers you a whole new mortgage with terms that are more personally favorable (in an ideal sense). Are you wondering how exactly refinancing works and how to start one? Before making a decision, make certain that this option is indeed suitable for your needs.

If yes, you may start shopping around for a lender who can offer a good interest rate with reasonable monthly payment. Choose the deal that has low closing fees and zero pre-payment penalty. Also, it would be a plus if your credit score is good. That way, you can likely receive a lower interest rate.

Overlook the 1% Rule – You Have Heard This One Before

Look:

Here’s an ancient rule of thumb you may be familiar with: Don’t refinance unless your interest rate could be at least 1% less. This isn’t always the case. There are cases wherein a decrease in rate of even 0.25% can still offer benefits. Take time to do the math, and you’ll see there could be a break-even point that can get you save money. Just match your break-even point with the duration of your plan to stay in the property.

The New Refi Guidelines are Now Changing Costs And You Will Pay 0.625% More

If you’ve tried a cash-out refinance on your property for high-balance mortgage in the year 2015, you’d have been restricted to a 70% loan-to-value ratio (e.g., how you’d like to refinance as compared to the property’s value) with higher rates. The interest rate of a 30-year fixed rate mortgage towards the end of 2015 was around 40%, supposing that a loan was “rate & term”. That same loan could amount to a striking 4.625% together with a cash-out refinance, the rest of the factors staying equal. Yes, you’d pay 0.625% more in rate just so you can pull cash out vs. doing the “rate & term” refinance under the same 70% loan-to-value case. Freddie Mac has offered the alternative to go as high as 80% loan-to value with bigger fees on loans in surplus of $417,000.

The new set of guidelines enables competitive rates up to a 75% loan-to- value ratio, with at least 700 credit score. The better your credit score, the better the fee and rate will be.

DTI – The Most Overlooked Math in Refinance

Here’s the deal:

Upon the processing of your loan application, each lender calculates your monthly debt payment, including the amount of future mortgage, and makes use of this to identity your DTI. The lower the DTI ratio is, the better the chances of qualifying for a mortgage.

Computing your DTI – Here Is How It Works

Your DTI ratio can be gauged when you divide your debt by your current income.

For instance, if your monthly income/salary is $6,000 and your debt expense per month plus your future mortgage expense is $1,850, your DTI ratio will be 30%. Most mortgage alternatives got particular DTI ratios.

How to decrease DTI ratio

If you want to decrease your DTI ratio, you must:

  • Reduce your outstanding debt
  • Limit the use of your credit card.

 What is the ideal DTI or debt-to-income ratio?

Most of the mortgage alternatives have particular required DTI ratios. However, the generally preferred maximum is roughly 36%.
What else refinance covers?

Your monthly mortgage payment

Monthly payments are typically composed of the interest and the principal. It could also include the escrow of insurance and taxes.

Principal

Principal is the funds borrowed or the outstanding payable balance of a loan. A part of the principal is usually paid with every mortgage payment.

Interest

Interest refers to the amount being charged for borrowing funds and can also be directly paid to your mortgage lender.

Property taxes

Property taxes get paid to the local government unit, depending on the assessed home value. This could also be a part of your monthly expense if an escrow system is made for this. Otherwise, it’s paid to the assessor’s office directly.

Hazard/ Homeowners insurance

A homeowner’s insurance secures you against some forms of damages to your property/ home caused by theft, fire, wind and other stipulated causes or insured scenarios. Basically, lenders need the amount of insurance coverage to be equivalent to the home’s value. If you reside in a location that is prone to natural disasters such as floods, earthquake, etc., you need extra policies to cover those forms of risks. For further details regarding the National Flood Insurance Program, get in touch with the Federal Insurance Administration by visiting FEMA’s website or calling them 1-800-427-4661.

In terms of property taxes, homeowners insurance gets paid either through your direct insurance company or as a part of your monthly payment via an escrow system.

Mortgage insurance

Bottom line:

Mortgage insurance can cover lenders against default because of non-payment of a mortgage loan. It’s also called the PMI or MI. It’s usually needed when the amount of loan already exceeds 80% of the home’s appraised value.

What is an escrow account?

With your escrow account, you can pay a part toward your insurance costs and annual tax every month which can be deposited to a systematized account under your mortgage servicer. When the insurance and tax bills are already due, your service provider makes the payment on your behalf.

What does my homeowners insurance cover?

Homeowners insurance can protect you from the damages to your home due to theft, fire, wind and other stipulated causes and insured cases. Basically, lenders need the amount of insurance coverage to be equivalent to the home’s value. If you reside in a location that is prone to natural disasters such as floods, earthquake, etc., you need extra policies to cover those forms of risks. For further details regarding the National Flood Insurance Program, get in touch with the Federal Insurance Administration by visiting the FEMA’s website or calling them 1-800-427-4661.

Interest rate – How Does It Work and How It Can Help You

Expressed in percentage, an interest rate is the charge of borrowing funds. For instance, when you borrow funds at a 5% fixed interest rate for the whole year, your interest rate will cost 5% of the total funds borrowed. The interest rate, together with the term and loan amount, could identify the extent of your monthly interest and principal payment.

When looking for a mortgage loan, consider several factors:

  • The loan term’s duration (for instance 30 years vs. 15 years)
  • How much you’re borrowing as compared to your home value
  • To what purpose the home serves (main residence, secondary residence or rental/ investment property)
  • Know your credit score
  • What the property type is (condo, single family, co-op, multi-family or townhome)
  • The mortgage program (for instance VA, FHA, Jumbo or conventional)

 

APR – What APR Covers?

Annual Percentage Rate (APR) – signifies the total amount of borrowing money for a mortgage. It covers certain interest closing costs, finance fees and points throughout your loan term, expressed as your annual rate.

It enables you to determine the real cost of your mortgage. The APR helps you compare the different kinds of mortgages offered by various lenders. Each lender calculates the APR based on the federal requirements and is obliged by the law to show the specific APR for the mortgage you’ve acquired in the Loan Estimate.

Should I pay discount points in exchange for a lower interest rate?

The longer your stay in your home is, the better the chances of you benefiting from paying points. Computing how long it could take for the initial amount to equal your savings on your monthly expense could help you identify whether it’s for you or not.

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Does my credit score affect my interest rate?

Your credit score does affect your credit history. It plays a significant role in identifying whether you qualify for the loan or not. The bigger your credit score, the more mortgage alternatives you’re likely to have and the higher the chances of qualifying a low interest rate.

What are points?

You could pay discount points to lessen your interest rate, depending on the available rates there are for your chosen mortgage type. 1 point costs 1% of the loan amount. This could lower your interest rate by less than 1%, usually from 0.250 to 0.375%. The extent of reduction due to paying points will depend on your chosen mortgage option. If you like, you can choose a higher interest rate and get a credit against the closing fees. These are called the rebate points.

Are paid points ideal for you?

If you stay longer in your home, the higher your chances of taking advantage of the paying points. To identify if this option is right for you, you need to assess how long it takes for the initial amount to equal your savings from the reduction. This refers to the “breakeven point”

What is a break-even point?

Another rule of thumb includes the break-even point. This is the period at which the amount you have saved from the reduction of mortgage payment compensates for the upfront loan amount. If it is costs $4,000 for your new loan, and the new mortgage payment saves you $350 per month, then your breakeven point will be 11 months. If you intend to stay in the property for over 11 month, you can save further. If this works out for you, you can thing about refinancing.

How to Calculate your break-even point

Step 1: Compute your monthly expense at the interest rate you’ll be charged with no points.

Step 2: Compute your monthly expense at the lower rate plus the points.

Step 3: Subtract the lower from the higher payment to get your savings per month.

Step 4: Divide the up-front cost for points by your monthly savings. The quotient is the number of months you’d have to live in the property to break even on the money you have paid for the points.

If you have no intention to stay in the property for long, it won’t make sense to buy points.

(PMI) Private Mortgage Insurance

Homeowners having less than 20% equity in their property or home when they do refinancing are required to pay for the PMI. If you’re already paying for it under your existing loan, this won’t really make a huge difference on your end. However, some homeowners, who own properties with decreased value since the purchasing date, could realize that when they refinance, they need to begin paying PMI for the first time. The decreased payments due to the refinance may not be that low to make up for the extra PMI cost. Lenders can readily compute whether you need to pay PMI and the impact on the housing payment.

30-Year Fixed-Rate Mortgages

This conventional 30-year fixed rate mortgage has been popular for a long, long time because of its fixed interest rates and lesser monthly payments. However, because the interest payments are being spread out in a 30-year span, you will pay more interest throughout the term of the loan as compared to the duration of your interest payment when you choose short-term mortgage plans.

15- and 20-Year Fixed-Rate Mortgages

With a short loan term and low interest rate, a 15 or 20-year fixed rate mortgage term could enable you to pay off the home loan faster and establish equity quickly. Although the monthly payments could become higher than the 30-year span, it could still give you an advantage. In terms of refinancing, 15 to 20-year fixed rate mortgages are more common.

 

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The 15-Year Mortgage: One Of The Most Desired Refinance Mortgages

Want to know the best part?

When choosing the 15-year loan to finance your home, in spite of the higher monthly payment, you can still save big time than picking the 20-year or the 30-year loans.

The 15-year plan is ideal for those who want to save more because of the following 2 reasons:

First, mortgage rate for the 15-year plan is nearly always lesser as compared to the rate on the long-term loans. Thus, since the interest rate is lower, less mortgage interest gets added by the home owner every month. Thus, the homeowner gets to repay less money to the affiliated bank.

Next, after the 15-year period, you no longer have to repay any mortgage as your loan is already fully paid. This is 5 years shorter as compared to the loans with 20-year contracts and roughly half the time it takes for the 30-year mortgage.

With the lower rate and the shorter team, over the span of the loan term, a homeowner who opted for the 15-year fixed-rate can get to save hundreds of thousands of dollars.

Note that a 15-year mortgage is not stretched out just like the 30-year plan. With the 15-year mortgage, loan payments could be hefty on principal, little on interest rates, and completed in just 180 months. The 30-year fixed rate mortgage is a different story.

Choosing the 15-year loan obviously pays down the principal big time as compared to the 30-year. The 30-year plan’s mortgage payments do not have the exact same ratio of principal to interest till the 18th year.

For those homeowners with the $625,500 as the mortgage loan limit in locations like in California or in New York, the 15-year mortgage cuts down long term interest fee by a whopping $253,000.

That is enough to fill your retirement account, fund your kid’s college education, or purchase a vacation house.

The 15-year mortgage provides a substantial long term savings to homeowners unlike the long-term ones. However, this program might not necessarily be safe for every person. The monthly expense for the 15-year mortgage is significantly bigger as compared to the payments on the 30-day mortgage.

Today, the payment for a 15-year mortgage could be 50% higher as compared to the 30-year.

This could bend the budget of some aspiring homeowners. It can also be difficult to quality for a loan with high payments because of the debt to income requirements set by the lender.

Thus, prior to choosing the 15-year mortgage for your next property/home, ensure that you can manage the monthly payments and make certain to check it with your chosen lender.

If you think that the 15-year mortgage is beyond your means but still desire to gain the striking benefits of the 15-year mortgage, then there’s another alternative for you.

As homeowners, there is no rule against refinancing. With low mortgage rates, it’s ideal to take into account the low-rate products—apart from the 15-year loan. Find out when will mortgage rates go up in 2016.

For you to mimic the advantages obtained from the 15-year loan, follow the steps below:

  • Refinance to 30-year mortgage
  • Request the lowest interest rate possible (choose the zero closing cost one)
  • Give an additional 50% to the lender per month to copy the scheme of the 15-year loan

With this system, you can already take advantage of the low rates now. At the same time, you can shorten the term of your loan. (From 30 years to just 15 years with the additional payments made.)

You can also stay in good control of the repayment plan or schedule. If there’s a month that you cannot give extra payment to the bank, you’re not obliged to.

Fixed Mortgages with Interest-Only Options

There are fixed rate mortgages that feature interest-only timeframes. This allows a homeowner to send interest-only payments through the first 5-10 years of the term, although the loan recasts when the interest-only timeframe is up to account for reduced payments sent within that span.

Thus, payments right after the expiration of the interest-only span are higher to make up for the lower payments made before. But the mortgage still is deemed “fixed”. It’s just recast to show the remaining number of months as well as the corresponding mortgage balance.

Benefits of Refinancing

Lower Monthly Mortgage Payments

Mortgage refinance reduces the monthly payment of homeowners. For example, a refinance can get to extend the loan term from 15 years to 30 years. This could then lessen the monthly costs. Let’s say the monthly payment of a $200,000 mortgage with 7% interest rate will plunge from about $1,792 to just $1,329 by modifying the setup from 15-year to 30-year mortgage.

Lower Interest Payments

If the interest rate has dropped since you have bought the mortgage, you’ll be able to do refinancing to lessen the interest rate further. This saves you lots of money. For instance, if you cut down the interest rate of a 30-year mortgage of $200-000 by, let’s say, 1%, from 6%- 5%, you can get to save more than $45,000 on interest.

Cash Out

A cash-out refinancing enables you to access your home’s equity when you take out another mortgage that’s beyond the current one you owe. To do cash-out refinance, you should have positive equity. Thus, the market value of your property should be higher as compared to your existing mortgage’s balance.

Fixed Interest Rate

A refinance could modify your existing variable-interest or interest-only mortgage to fixed interest mortgage. A fixed interest mortgage gives you peace of mind since you know you can manage your monthly payments. If you’ve got an interest-only loan and you refinance it to a fixed interest loan, your monthly payment might not drop. However, you can save money from interest payments.

Escape from adjustable rate mortgages.

Refinancing enables people with ARMs or adjustable rate mortgages to shift to fixed-rate loans. This is a benefit even though they do not save money on their monthly payments readily. If you’ve got an ARM, to refinance to a 3-year mortgage can’t just lessen your rate but also greatly enhances the safety of the loan by removing the risk of increasing rate.

Loan mergers – Combine Your Two Loans Into One

Refinancing allows you to merge your second mortgage or home equity with the home mortgage. This can help you save money since it allows you to pay one lower rate on the whole amount rather than a low percentage on the primary mortgage and a higher one on the rest of the loans.

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Secrets of Mortgage Refinancing

Close Your Loan towards the End of the Month

It doesn’t really matter if you get to close the loan on the 5th day of the month or the 27th, right? The answer is no.

Pretty cool, right?

The borrowers who get to close mortgage loans towards the end of the month lessen the sum of prepaid interest borrowers have to pay on their 1st mortgage loan payment. This is a basic strategy that can already save you bucks.

You can have the freedom from the lender to choose the exact day of the month you like to close the mortgage.

For instance, if you tend to close it on Nov. 5th, and your 1st mortgage payment will be due after January 1st, then your 1st payment will obviously include the interest rate added in the month of December. It also includes the interest rate added in November. When you close it on Nov. 5,  that would be a total of 26 days’ worth of interest.

However, if you strategically close it on Nov. 27, you can only pay 2 days’ worth of interest for the month of November. If the interest is $25 per day, closing on Nov. 5 costs you $650 for the month of November for your initial payment. However, when you close on Nov. 2, you’ll just pay $75 on interest.

Nobody Knows Where Interest Rate is Heading

Your chosen mortgage lender must study the market and must have the knowledge whether interest rates are going to increase or decrease in the future. However, even the wisest lender couldn’t really tell you the exact interest rates in the following weeks or months. In fact, nobody can.

Rates are bound to go erratic. If you are getting quotes out there, it does not mean you are out getting locked rates till you request them to lock the rate. Do not assume that it’s already locked unless it’s in writing.

When you lock your interest rate, it remains the same even though the market’s rates increase or–the drawback– decrease. Ensure that you have the details about how long the lender is going to lock the rate. You should have a written agreement on this.

A No-Cost, No-Point Loan Doesn’t Actually Exist

You may have heard lenders advertising no-point, no-cost mortgage loans. Most of the lenders who market such loans roll the fees of originating their mortgage to your interest rates. They will charge you higher for their “no-cost” loans.

To avoid being a victim, ensure that you have the idea how much exactly you’re paying for the loan, even though the ads flag the “no-cost” line.

Do not hesitate to ask about the entire cost of financing throughout the whole period for options like rolling the cost into interest rates vs. no points vs. paying some points. Then, select the lowest cost.

Doing Refinancing Does Not Always Make Sense — Even Though Your Payment Falls

Multiple homeowners readily decide to do refinancing if the plunge in the monthly payment enables them to pay the amount of the refinance back in a shorter span, like at most 3 years.

This isn’t the soundest financial tactic. Many lenders tend to ignore this notion.

If you’ve saved $225 on your loan payment right after you do refinancing, it could take you about 25 years to fully pay the closing fees back. However, this pay-back analysis overlooks the rise in your loan’s actual term and the resetting of the amortization process.

For instance, you were able to pay off fourteen years on a 30-year loan. If you do refinance to another 30-year mortgage, even if it has a much lower interest, you still might pay more in the long run since you’re replacing a loan with 16 years to pay with another one that needs 30 years.

The amortization cycle then restarts from the top. As you begin paying off your home loan, most of the payment just goes to paying off the interests. During your 14th year in the 30-year mortgage, most of the payment goes to the pay down of your mortgage’s principal payable balance. If you do refinancing on that 30-year mortgage, your payments will just dominantly go toward the payment of your interest.

Take a closer look at the total cost of financing over the anticipated holding span for both the current mortgage and the proposed one, and choose the one that costs you less.

What the Mortgage brokers don’t want you to realize:

There’s a bonus involving that mortgage broker that could harm you. Mortgage brokers usually receive 1% bonus from your house loan for every single 25% in interest rate.

For example, a mortgage broker has a bonus of extra 3% that is equivalent to $9,750 on top of the $8,125 for your loan source fees. He will then earn a whopping $17,875 after just bare hours of work.

If your mortgage lender gives you the rate that you’ve just qualified for, you’ll always pay $1,940 per month. Thus, you’ll always pay $2,040 in excess money each year because of the lender’s greed. These unnecessary cost and fees can be prevented by taking time to do some investigation.

 

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Tax Deductions For Your Refinance Mortgage

#1: Mortgage Interest Paid

The mortgage interest that’s paid to the lender is tax-deductible and, for some of the homeowners, interest paid can give a huge tax break—particularly earlier in the loan term. This is due to the fact that the standard mortgage amortization schedule is front loaded with mortgage interest.

Today, the annual interest payment on a 30-year mortgage exceeds the annual principal payment till the 10th year of the loan term.

Mortgage interest tax deduction can be extended to second mortgages as well.

The interest that’s paid on a refinance loan HELOAN or home equity loan, and HELOC or home equity lines of credit are all tax-deductible too. But restrictions may apply for those homeowners who increase their mortgage debts beyond the fair market value of the property.

The IRS or Internal Revenue Service enforces a $1 million size cap for loans. Beyond this cap, your loan can be tax deductible.

This is a reason why there are homeowners with jumbo mortgages who limit their loan to just $1 million each.

Tax Deduction #2: Discount Points

Mortgage tax deductions could extend beyond the monthly payments. The discount points paid in association with a property purchase or refinance are entitled to a tax deduction as well.

A discount is set one at a time, at-closing fee that could get a borrower access the mortgage rates under the existing market rates. A discount point could cost 1% of the loan size of the borrower.

As per the IRS, discount points can be considered “prepaid mortgage interest” since it’s an advanced payment on a mortgage in trade for lower interest payment in the long run. This can make discount points entitled to tax deduction.

The extent of deduction for discount points could vary according to the loan type.

If the discount points are being paid together with the purchase, the cost could be subtracted in full in the exact year when they got paid. In terms of refinance, discount points may not always be tax-deductible within the year when they got paid. Refinance discount points are usually amortized throughout the course of the loan. The cost of a single discount point on a 30-yeat loan could be deducted at 1/30 of its value per tax calendar year.

 

Refinancing with Bad Credit:

The Refinancing Process

Though the whole refinancing scheme isn’t the same for all lenders, the process could change if the borrower has a bad credit. To get the best deals, it’s suggested that you:

1. Look for a good mortgage banker

Looking for an experienced and licensed mortgage banker can help you begin your refinancing journey. Though you’ll most likely reach success with most mortgage bankers, choosing to work with one that has been in the trade for long years can help you get the best rates, given that you have a bad credit.

2. Be pre-qualified

Though becoming pre-qualified is a basic and swift process, it’s still important to do this step before you apply for a loan. Doing this enables your lender to have a grasp on your financial status and your loan capacity. Give your documents to your lender, showing your debt, income, and assets. You will then get informed on the possible loan option you’re qualified to have.

3. Fix bad credit issues

After you have assessed your financial status, work with your lender to fix your bad credit issues that arose during the assessment. There are issues that can easily be fixed. There are also some that could take time to mend. If there are issues that can be fixed fast, fix them before your application process starts. A good lender can give you a good advice on how to better your credit score to get a better loan with lower interest rate.

4. Apply

Fill out an application form with your personal information, including your financial and job history. Do this step completely and accurately to avoid unnecessary troubles along the way.

5. Getting approval with bad credit

Whether you’re going to qualify or not is out of your control. Once you have submitted you application, it will be totally up to the lender whether you can proceed with the refinance or not. But usually, as long as your documents are intact, you can most likely make it. After receiving your application, the lender is required by the law to give you 2 files: a Good Faith Estimate and a Truth in Lending Disclosure.

A GFE or Good Faith Estimate shows an estimation of the fees and closing costs of the loan. It also summarizes the terms of the loan as well as the monthly payments. The final decision whether to refinance or not is up to an underwriter that reviews the details of your application. If you have a really bad credit score, the approval might take time.

A Truth Lending Disclosure shows your APR or Annual Percentage Rate. This shows how much is the sum of the closing costs of your loan. Note that if your APR is totally not the same with your actual interest rate, hidden costs might be incurred.

HARP Refinance Mortgage

The HARP loan is a type of home mortgage refinance program that was officially introduced in March 2009. This gave a lot of homeowners the chance to refinance their existing loan rates without having to incur whole new loan insurance, no matter what the LTV or loan-to-value is. HARP means Home Affordable Refinance Program and will be available till December 2016.

If the underwriter declares that you’ve passed the requirements of the traditional mortgage, you could be eligible for refinancing with today’s mortgage rate without having to pay down the principal and mortgage insurance.

Here are more details about the HARM refinancing program of the government:

The HARP mortgage began in April 2009. This refinancing program has lots of names. The governmental body calls it the Home Affordable refinance Program. It’s also called Make Home Affordable, harp mortgage, Obama Refi, Relief Refinance, A Better Bargain for US Homeowners, and DU Refi Plus,

The requirements for the HARP mortgage are:

  • The loan should be officially backed by Freddie Mac or Fannie Mae
  • Your existing mortgage should have a note date of earlier than May 31, 2009.

As long as you meet the two criteria above, you can already apply for the HARP loan. If your loan is USDA, FHA, or VA, or jumbo mortgage, unfortunately you can’t apply for HARP.

Underwater FHA loans could get refinance through the FHA Streamline Refinance Program. On the other hand, underwater VA loans could be refinanced via the VA IRRRL mortgage program.

Underwater USDA loans could get refinance through the USDA Streamline Refinance program that’s accessible in most of the states.

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Martin - Head of Real Estate and Finance at RateTake
Martin is Head of Real Estate and Finance division at RateTake. He creates content that helps people understand and make the right decisions for their financial future.
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Written by ratetake

ratetake

Martin is Head of Real Estate and Finance division at RateTake. He creates content that helps people understand and make the right decisions for their financial future.