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Time to Refinance Your Home Loan Yet?
By Gaurav & Brook Bhagat
Editor’s Note: Although this article is specifically written for the U.S., readers can take the idea, change the numbers according to their country, and still probably benefit from this information.
Is it time to buy a home or refinance your existing home loan? Home prices and interest rates seem to have hit rock bottom and are creeping up again.
There is a graphic saying among stock market investors: “Buy when there is blood in the streets.” 2008, ironically, was the year to buy stocks. Investors who bought when things looked dismal are rewarded multifold now. It seems that, for the housing market, 2013 is the year. It’s bottomed out and it’s starting to move up. When mortgage rates start moving up after historic lows, it’s certainly time to think about it.
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I recently refinanced my FHA 30-year fixed-rate loan to a 15-year conventional loan. Due to the lower interest rate and lower term, I was able to cut 15 years off my loan on less than $100 extra per month. Like any other investor, I was afraid when I bought my home three years ago and saw my property value plummet 10-15% in couple years. Finding the absolute bottom of anything is very rare, so I trusted my gut and took the risk of buying the house. After refinancing my loan and seeing home prices go back to what I bought it for, it looks like a sweet deal now.
One certain way to save is if you purchased home a few years back and now have 20% equity in it, then you should be able to get rid of the mortgage loan insurance. In my case, after purchasing, I spent some money upgrading the floor and a few other home improvements, which brought my equity up to almost 25% of the home value. Getting rid of mortgage insurance alone was a few hundred dollars’ savings per year for me.
The most important question to consider when refinancing is whether you are going to keep the property long enough to recover settlement costs and save something out of it. Settlement costs typically include a loan application fee, appraisal fee, credit check, origination fee, title, lawyer’s services and a few other things. Depending on the points, your rates can be lower or higher. Choose higher points if you are going to keep the property, and choose lower or zero points if you plan to sell in the near future.
Another issue that comes up is how to calculate when you are going to offset your settlement costs. In my case, I opted for zero points and my closing cost was about $1800 (choosing higher points/upfront payment will lead to lower closing costs). Of course, it took a while to hunt for the best rates and lower settlement fees, but spending a few days comparing rates online and calling a few companies saved me thousands of dollars. The difference in my previous loan and refinanced one is significant-- I am now paying almost triple towards my principal. This saves me almost $300 per month ($200 net + $100 which I am paying extra by opting for a 15-year loan term) towards my home equity, with the settlement costs being offset within one year. Over the period of five years, I will be able to build thousands of dollars in my home equity.
For a general example, if a home is worth $100,000 and refinancing can save you $100-$150 per month in interest by lowering the monthly payment, the owner will be able to recover settlement costs typically within 1-2 years and be able to save in after that.
With the world population rising rapidly, surpassing seven billion, one thing is sure: lots of people will need homes to live in, and the earth is not going to produce more land or property. In the long run, investing in property, including buying a new home, is a good bet, especially with rates being close to historic lows, signaling a rise after bottoming out in 2013.
Another thing which might affect your savings in home equity is income tax. Mortgage interest is tax deductible and can save you a lot of tax dollars. Refinancing at a lower rate can increase the tax you pay but choosing to cash out can give you the opportunity to refinance at a lower rate. This choice can also provide some extra cash which, if you can afford it, you can put back into your property by investing in home repairs or improvements.
Another quick tip to save up some green dollars is to refinance the loan with cash out and pay off any existing high interest rate credit card loan, auto loan or personal loan. Rather than paying 10-30% on your credit card loan, you will end up paying just 3-5% on your home loan, which alone will save up thousands of dollars over time.
What should you look for when hunting for the best deals? The APR (annual percentage rate) is important to look at when comparing similar term and points loans. The APR will typically include the settlement costs, and it gives a fair idea to the borrower of the best deal out there. For example, some lenders can advertise a 3.5% rate while their APR is 5%, but other lenders can have similar term and points but a 3.625% rate and 4.875 APR due to their lower settlement fees.
There are some great websites for mortgage calculators. Here is the one (15 years v/s 30 years) I used to compare my old 30 year loan with the 15 year refinance I wanted to do. After inputting the data, I was able to see my amortization schedule by month and also by year. I was able to see my due balance in my existing loan over a five-year period and determine my savings. For example, I will pay about $6000 extra (a little less than $100 per month) in five years due to reducing my loan term to 15 years, but the difference between my 30-year loan balance and 15-year refinance balance in five years was so significant that paying $6000 extra looked like nothing. If I sell my home after five years, I will be able to rake in tens of thousands in home equity savings. Being a bit active about your finances and taking initiative at dire times can go a long way toward the goal of having some decent equity when you retire.
Disclaimer:
Although some of this information has been obtained from sources which we believe to be reliable, we do not guarantee its accuracy or reliablity. This article is for information purposes only; please consult your financial advisor or real estate lawyer before making any financial decisions.
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