This week on NJ Real Estate Today Radio, we will be join by Albert “Al” Rapoport of GMI Home Loans. Al will answer all of your follow-up questions. Please contact him on his cell phone. 908-244-8107. Our topic will be When and Why to refinance. Every new home buyer often asks when would be an appropriate time to refinance. We are going to cover several scenarios that new and exisiting homeowners encounter if and when it becomes time to refinance.
Most Popular Reasons to Refinance
- 1) Rate reduction
- 2) Term reduction
- 3) Debt and/or multiple mortgage consolidation
- 4) Fix an ARM
- 5) Cash out
- 6) Lower payment
- 7) Take off a co-signer
- 8) Buy out a divorcing spouse
- 9) Remove mortgage insurance
Benefits of a Rate reduction
Rate reduction in and of itself is no reason to refinance, although this reason happens to be one of the most popular reasons a person decides to refinance. In theory, one can lower their rate by 1%, which ultimately reduces an individual’s monthly mortgage payment but the loan itself can be extended and still lack a net tangible benefit until the break even point.
Ex: An individual with a 30 year fixed rate at 6% might be interested in a refi of at 5%.
Usually one can lower their rate significantly by taking a shorter term; however this will usually net a higher payment. Recuperation time is key in a case where one is interested in reducing his or her rate. One must ask him/herself:
How long it will take to recoup the cost of the loan in order for this rate reduction to be worth it? In the real estate sales business we call this the break even point.
Term reductions by themselves are tricky. Many times, a borrower can pay bi-weekly or make extra principal payments and shorten their term on their own without a refinance. Term reductions are usually most beneficial, when combined with another “reason to refinance” and are usually not when it as a stand along benefit.
Debt and/or multiple mortgage consolidation
- a. Very common reason to refinance. One will either look to combine several pieces of higher interest rate debt into a much lower rate secured mortgage to lower their total monthly outgoing debt
- b. One may combine multiple mortgages (junior liens are at higher rates than first liens) into one monthly payment.
- c. Key factor here is to analyze the before vs. after monthly outgoing debt and weigh in the costs of the loan.
Convert an ARM into a Fixed Rate Mortgage
- a. Converting an Adjustable Rate Mortgage is one of the best reasons to refi and a strong net tangible benefit to the borrower even by itself. With a long term rate horizon predicted to increase from our current historic lows, it is unlikely that someone would want to stay in an ARM as rates are increasing.
- b. Over the past couple years, people in ARMs have generally benefited from the low interest rates.
- c. Often times, people will look to convert an ARM into a fixed rate before that ARM begins to adjust.
ARMs are usually fixed for a specified period of time whether it be 1, 3, 5, 7 or 10 years and thereafter they become adjustable based on a preset schedule and according to a specific index + margin.
- a. Borrowers may cash out the equity in their homes up to 85% FHA or 80% conventional.
- b. Most banks require a letter from the borrower specifying the reason for the cash out
- a. The cost of the refinance must be weighed in conjunction with the before and after payment
- b. The borrower should consider what lowering their payment means to their loan term
Take off a co-signer
- a. Some first time home buyers require a co-signer to help strengthen their application. Often times, this co-signer is needed to help lower a high debt-to-income ratio.
- b. These first time home buyers may later opt to refinance in order to have the co-signer removed from the mortgage. To do this, they must show that they are able to qualify for the loan by themselves.
- c. Remember that a co-signer was needed in the first place for a reason. Removing them means that the first time homebuyer must be able to show that they “can stand on their own 2 feet.”
Buy out a divorcing spouse
- a. similar to a cash out refinance
- b. usually the spouse keeping the home will cash out some equity (pursuant to a divorce decree) to buy out the other spouse
- c. A quitclaim deed releasing the divorcing spouse’s rights to the property is usually executed at closing
- d. The spouse staying in the home must be able to support the mortgage by himself/herself
Remove mortgage insurance
- a. some people will refinance to remove mortgage insurance when they feel they have the necessary 20% spread between what they owe and what the home is worth
When is the right time to refinance?
There is a saying that one should only refinance if there is rate is going down by 1%. In fact, the benefits of each individual refinance should be weighed on their own merits and not by some arbitrary number like 1%.
- a. Consider that often times, a loan may have a tremendous benefit though the rate is only going down slightly or maybe even up in some cases.
- b. Rate, by itself, is not the sole consideration.
- c. Each refinance’s closing costs must be considered in conjunction with weighing the pros and cons of wanting to do the refinance in the first place.
- d. Some refinances must happen immediately (such as in the case of an ARM about to adjust or a divorce).
- Other refinances can be delayed or put off indefinitely if the benefits are marginal.
What type of loan to consider when refinancing:
1) Available mortgage loan programs in 2011 are fewer than what was available just a few years ago.
- a. Interest only loans are much more difficult to obtain
Interest only loans may be fixed or adjustable. They are interest only for a preset time period, usually 10 or 15 years. At that point, if one has only paid the minimum payment, then their balance is exactly the same as what they took out loan in the originally and the loan will convert itself into a principal and interest loan. This P&I payment will be based on the remaining terms which will cause the payment to increase significantly.
2. Low initial payments
- b. terms longer than 30 years are all but priced out
- c. terms of 50 years no longer exist
- d. 2/28, 2/38 and 2/48 no longer exist
- e. Option ARMs/Negative Amortization loans are all but gone
3) In today’s market, the most popular loans are all principal and interest. Under that category, one can consider an ARM versus a fixed rate mortgage.
- ARMs are more short term thinking in an environment where rates are expected to increase.
- ARMs are mainly taken by people who don’t plan to live in a home, or keep the original mortgage, past the initial fixed period.
- ARMs come with a lower rate/payment
- ARMS have an initial fixed period of 1, 3, 5, 7, or 10 years depending on whether it is FHA or conventional. Thereafter, the ARM will adjust usually once per year pursuant to an index plus margin
One should consider the implications of staying in a home past the initial fixed period of the ARM (i.e. need to refinance) Fixed rate mortgages provide stability of knowing that one’s principal and interest payment will remain the same throughout the course of the mortgage.
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