Contrary to popular belief refinancing your mortgage isn’t always about lowering your interest rate and payment. In fact, would you believe me if I told you I can, in some very common scenarios, increase your mortgage rate and payment and still save you thousands of dollars?
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In a rising rate environment, here are a few of the scenarios I see where refinancing a mortgage make a lot of dollars and sense.
Refinance to Get Rid of Mortgage Insurance
The economy is strong, tax cuts passed, unemployment is low, and employers are raising wages. For many homeowners and hopefully for you, these factors have improved their financial situations.
The most common scenario that I encounter is a homeowner that is considering the refinancing of their current mortgage to remove mortgage insurance
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This can be a significant chunk of your monthly mortgage payment for the sole purpose of insuring the lender against you not paying your mortgage. That’s blown money, as far as you’re concerned. Get rid of this as fast as you can.
Often the fastest way is refinancing. This requires you to refinance your current mortgage into a new conventional mortgage with a loan to value of less than 80%. That means you have a mortgage that is less than 80% of the current value of your home.
Okay, so how do you do that without coming up with a ton of cash? Interestingly enough, your 20% home equity might already be there.
Here are the most common scenarios I see in this category of refinancing opportunity.
Many homeowners get their mortgages when their finances aren’t perfect, either because they’re young or a little dinged up by the economy. When they buy their home, they couldn’t afford a big down payment, or they had a low credit score. As a result, many of these borrowers end up with a higher than market interest rate mortgages or an FHA loan with a life of the loan mortgage insurance.
Time often cures and improves a lot of these factors. Then, armed with a better credit score, a steady pay down of your mortgage, and rising home values these same borrowers can often refinance that mortgage, get rid of the mortgage insurance, and sometimes even get a better rate.
Do a Cash-out Refinance to Leverage Home Equity
Another popular situation is when a homeowner is considering a mortgage refinance to cash-out some of their equity for home improvements. Likewise, real estate investors are doing a similar thing, using a cash-out refinance to improve the current property or purchase additional properties.
The opportunity to cash-out some home equity is being created not only by building equity from the payment of your mortgage but also takes advantage of swiftly rising home prices.
In both of these scenarios, a homeowner or a real estate investor is likely to break-even fairly quickly for a couple of reasons. First, home values continue to appreciate and look like they will for some time. Second, any home improvements typically increase the home’s long-term. Finally, if you’re an investor or even looking to buy a second home, there are still some great investments to be had.
Refinance into a Shorter Term
Here’s another situation where refinancing, even when mortgage rates rise, can save you thousands of dollars. That is refinancing for to remove mortgage insurance or leverage cashing out some equity, but at the same time matching or reducing the term. Unfortunately, most miss or never consider this opportunity.
The current economic trends have created a perfect opportunity for many homeowners to shorten the term on their mortgage. Even though interest rates are trending upward, they’re still historically low, and shorter-term loans typically have lower rates.
Here’s a specific example where we do the math.
Let’s consider a homeowner has a 3.99%, 30-year fixed rate mortgage, which they have been paying on for ten years. They’re now considering refinancing that mortgage to a 4.25%, 15-year fixed rate mortgage.
As a result of this refinance, although their interest rate goes up to 4.25% and their payment increases $231/month, they’ll pay off their mortgage five years earlier and save $15,592 in interest.
Real estate investors are also using this strategy. In their cases, they are further leveraging the fact that rents have been steadily climbing for several years. Consequently, they can refinance into a shorter-term mortgage, pay off the property (asset) earlier, maintain a profit margin, all the while absorbing the full increase in payment into their current rents.
If You Refinance, Watch Your Fees and Closing Costs
If you do decide to consider refinancing your mortgage, it’s very important to keep your fees and closing costs as low as possible. Here are a few tricks of the trade to reduce the costs in of any mortgage.
- Don’t pay points! This can be a dirty little trick loan officers pull to show you a very low rate. But, you end up paying for it big time in the total cost of your loan.
- Avoid the temptation to roll upfront closing costs into the loan amount or raising the rate to offset these same costs. Increasing the loan amount or buying up the rate will increase your interest expense over the life of the loan.
- Shop your homeowner’s insurance. You can almost always get a better deal, which will lower your escrow requirement and thereby lower your monthly payment.
- Keep at least 20% equity in your home to avoid mortgage insurance
- Work on your credit to get and stay above 720 at all times
Questions? Comments? Talk to me on Twitter @billrice and please include a link to this article.