The decision to refinance your mortgage should be made wisely. When considering switching, it is important to work with an experienced and knowledgeable professional who can ensure that a refinance is really in your best interests.
There are two types of refinancing: rate-and-term and cash-out. Here we look at the differences between the two types and how you can find out if an interest rate fixture refinance is in your best interests. We also explain the current interest rate environment and why all of these considerations are relevant right now.
Interest-and-term versus cash-out refinancing
Interest and term-oriented refinancing means that you replace your existing mortgage with a new one with more favorable terms. These beneficial terms could be, for example, a lower interest rate moving from an adjustable rate (ARM) mortgage to a fixed rate or even a shorter term (for example, from a 30 year mortgage to a 15 year mortgage). Refinancing on time and at interest rates can include the repayment of a second mortgage IF the second mortgage was used to buy the house, also known as the second mortgage. This loan amount is limited to the repayment of ongoing mortgage and closing costs. Interest and term refinancing generally have lower interest rates and allow a higher loan-to-value ratio than cash-out refinancing.
Pay off refinancing
Another option is a cash-out refinancing. A payoff refinance also replaces an existing mortgage with a new one, but comes with a higher loan amount that allows cash to be withdrawn from the equity in the home. This additional money can be used for home improvement, debt consolidation, tuition, or any other borrower’s needs. Since the loan-to-value increases with a refinancing from the disbursement, it is considered a riskier loan. For this reason, the interest rates are usually higher and there are stricter qualification requirements than for interest-oriented and term-oriented refinancing.
Is interest-and-forward refinancing in your best interests?
Getting a mortgage loan costs money – lender fees, valuation fees, title company fees, and so on. These fees can add up to thousands of dollars and add to your mortgage balance. Refinancing should only be done if it is really in your best interest.
The main benefit of a cash out refinance is the ability to use the equity in your home for another purpose. If that purpose is debt consolidation, a home equity line of credit or credit card may be a cheaper option depending on the amount. On the other hand, the interest rates on one mortgage are often lower than on a second mortgage or credit card.
It is also important to evaluate the cost of refinancing against the savings made. With an interest and maturity refinancing, a slight interest rate cut may not be worth the cost. For example, if your current mortgage is $ 300,000 at 5% interest, the principal and interest payment will be $ 1,610 per month. If you refinance a new $ 300,000 mortgage at 4.75%, your new monthly payment will be $ 1,565 / month. That’s an annual saving of $ 540. The cost of refinancing can be $ 3,000 or more, which means it will take over five years to see the benefits of the refinancing.
In making this calculation, it is important to compare apples to apples. If your current mortgage has a term of 30 years but you have been paying it for 5 years, a new term of 30 years extends the term by 5 years – a longer period with interest payments.
One case that almost always benefits the borrower is the removal of mortgage insurance, or MI. If you currently have an FHA mortgage and your financial situation has improved, a conventional interest and term refinancing can reduce or eliminate the MI amount. If you currently have a conventional mortgage with MI and the equity in your home has increased sufficiently, an interest- and term-related refinance will override the MI requirement.
The relevance of the current interest rate environment
Above: 30-year U.S. mortgage interest rate chart (Source: ycharts.com)
Interest rates remain near their all-time lows and are remarkably similar to a year ago. If you received your current loan before 2020, it is worth checking whether refinancing makes sense.
If you are thinking about your refinancing options and would like an expert opinion, please contact our mortgage team. We are here to help. You can also try our mortgage refinance calculator or sign up for a free seminar. Elevations is an equal opportunity lender.