When to Refinance Your Home

When to Refinance Your Home

Switch from an Adjustable Rate Mortgage (ARM) to a Fixed Rate Loan

If your adjustable (ARM) has moved up on you in the last few years and you don’t feel like starting with another low rate only to watch it move again,  consider refinancing into the security of a fixed rate loan. You must remember that all fixed rate loans are not the same.

Today’s market offers numerous choices for loans that are fixed for a shorter time than the traditional 30 or 15 years. Loans are available with fixed rates for 3, 5, 7, and 10 years and the shorter the initial fixed period, the lower the interest rate. All of these loans are amortized over 30 years so there’s no need to worry about the payment being too high. All you need to do is match up how long you expect to keep the loan with the closest fixed term. This may be shorter than how long you plan on keeping your home, if you feel comfortable with the refinance process.

At the end of the fixed term, these loans automatically convert into ARMs with adjustments annually, so there is no balloon payment.  Often the current fixed rates will be above the rate on your current ARM, unless of course, you are several years into your adjustable. You will need to decide if the security and insurance against further rate increases is worth the additional payment that you might incur.

Switch from a Fixed Rate Loan to an Adjustable Rate Mortgage (ARM)

Switching to an adjustable (ARM) really can make sense in some situations. If you’ve recently decided to start looking for a new home, or will be relocating within the next few years, it may make sense to evaluate your current loan. By switching from a 30 year fixed to a low rate adjustable or short term fixed, such as a 3 Year Fixed, you can save substantially over the remaining time that you’ll be in your home. In this type of situation it almost never makes sense to pay closing costs, so shop for a no cost loan with a slightly higher rate. Also, don’t take a loan with a prepayment penalty, unless the prepayment is waived upon sale of the home. This strategy can be best explained by showing an example. For simplicity, we’re assuming that your loan balance is the same on both the refinance and original loan.

Take cash out of your home

The primary advantage of home mortgage loans is that the interest costs are deductible for tax purposes. If you are currently paying a higher rate of interest on credit cards, car loans, or other forms of debt that are not deductible, it may make sense to pull the cash out of your home (provided that you have the equity) and use it to pay off those other debts.

Lenders will typically allow you to borrow up to 75% of the appraised value of your home in a cash out refinance. (Some lenders will go up to 80%, however the loans offered will be less competitive than at 75%.) Paying off other bills or credit cards, buying a new car, sending the kids to college, investing in an Internet start-up, or buying additional real estate are all good reasons to refinance your home and take cash out.

Even if you’re able to keep you credit card interest rate at 8-9% with low introductory offers, when you consider the tax savings of your mortgage interest, you will be paying less interest if those balances were part of your mortgage instead. If you are paying 8% on your mortgage and your tax bracket is 33%, your net interest rate is 5.3% which is still less expensive than any credit card program over time.

Eliminate Mortgage Insurance (MI)

If you purchased your home with less than 20% down, chances are you have a loan that is insured by “Mortgage Insurance” (MI). Most borrowers are aware that they are paying MI on a monthly basis, but you can check your mortgage statement if you’re not sure. As your home appreciates or your loan balance decreases (or a combination of the two), your equity in the home will exceed 20%. At that time a favored method of eliminating the MI tied to the loan is to refinance. The savings of eliminating the MI alone will often warrant refinancing.

Be aware that mortgage lenders value your property at what comparable homes have sold for in the last 6 months, not the price at which they are currently listed. If you are close to that 20% mark, ask your mortgage source to provide you with a “comp search” estimate (this service should be available for free) which will give you an idea of how your lender will view your home’s value.