Refinance Considerations
With any mortgage transaction, we believe it is critical to determine that it is the right decision and the right time for our clients. We provide our clients with uncompromising advice for two reasons:
1) It is simply the right thing to do. For many people, their home is their greatest asset, and we take the impact we can have on our clients’ financial lives very seriously.
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2) We are built on our reputation and relationships. By focusing on how we can best serve your long-term personal and financial goals, we build lasting client relationships.
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There are two types of refinances: no cash-out (aka rate and term) and cash-out. A no cash-out refinance is easier to qualify for and often has better rates than a cash-out refinance. The downside is right in the name: with a no cash-out refinance, you are not able to tap into the equity in your home (and with a cash-out, you are). Each has its own set of considerations.
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Considerations for Both Types of Refinancing
Return on Investment (ROI) Analysis
A no cash-out refinance is most often used to lower your interest rate. The annual savings can be calculated by multiplying your loan amount by the interest rate savings. An example:
Jane has a $480,000 loan on her home at a 7% interest rate. With a no cash-out refinance,
she can lower her interest rate to 6%. Jane is cutting her interest rate by 1%.
1% x $480,000 = $4,800
By doing a no cash-out refinance, Jane will save $4,800/yr, or $400/mo.
So now we have the ‘return’ piece of the ‘return’ on the ‘investment’ equation. The ‘investment’ side is the cost involved with refinancing. If the cost is $2,400, then it would take Jane 6 months to cover the cost of her refinance. Beyond that point, Jane would save by choosing to refinance.
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Covering All Fees With Lender Credit
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When considering the ROI of refinancing, you could find it is possible to lower your rate and have all your closing costs covered with lender credit. While this may not be the best way to structure your refinance, given you could get a lower rate by not taking lender credit, it could be a way to lower your interest rate, and your payment, without paying any closing costs.
Cash-Flow
Depending on how you structure your refinance, your payment could increase or decrease.
Coverting from an Adjustable Rate Mortgage (ARM) to a Fixed Rate
You may want to refinance to get out of an ARM and into a loan with a fixed rate. If you can lower your interest rate and go from an adjustable rate to a fixed one, this can be an easy decision. In many cases, this can be one of the most challenging decisions to weigh. Consider the following:
John has an ARM with a current rate of 4%. It will stay at 4% for the next 2 years, but
then it could change based on where the market conditions are at that point. His rate
could go up to 10% in the next few years if he doesn’t refinance, or it could stay the same,
or it could even come down. John could refinance into a new mortgage today at a 6% rate,
but it would cost him $2,000. What should John do?
As much as we’d love to have an answer, nobody can really know. By refinancing, John could end up spending $2,400, pay more interest for the next two years, and end up selling his home. He could end up saving himself significantly by avoiding a much higher interest rate. Or, he could end up somewhere in between. In a situation like this one, all anyone can do is weigh the pros and cons and make a more educated decision.
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Considerations for Cash-Out Refinancing
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Loan-to-Value (LTV) Limit
Your total new loan amount cannot exceed 80% of your home’s value for most mortgage products. On a Conventional cash-out refinance, the rate can increase significantly as the LTV increases.
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Return on Investment (ROI) Analysis
There is an extra layer to consider on a cash-out refinance – what will you do with the cash? If it is invested, will the invested amount have an ROI that exceeds the interest rate being paid on it? It is also important to consider the loss incurred by accepting a higher interest rate than would have been attained with a no cash-out refinance. Consider the following example:
Jill currently owes $200,000 on her home, and is deciding between two refinance options:
1) Borrowing $200,000 and getting a 6% interest rate
2) Borrowing $300,000 and getting a 6.25% interest rate
If Jill goes with option #2, it is important for her to keep in mind that, she will be paying
0.25% more on the $200,000 she already owes than she would if she went with option#1.
That cost can be calculated to be: 0.25% x $200,000 = $500/yr.
While this may not factor in heavily enough to change the final decision, it is worth considering.
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Getting a Home Equity Line of Credit (HELOC) vs a Cash-Out Refinance
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A HELOC functions similarly to a credit card in many ways: it comes with a credit limit, a minimum monthly payment, a variable interest rate, and you don't pay any interest if you don't use it. There are some significant differences, a few of them are:
-Your house is used as collateral (the creditor can foreclose on your home to seek repayment)
-The interest rate is significantly lower
-Interest is calculated and accrued daily, unlike a credit card where you will usually pay no interest so long as you pay it off every month
With a HELOC, you can access your home's equity without making any adjustments to your current mortgage, unlike a cash-out refinance. While we do not offer HELOCs, we would be more than happy to advise you on whether or not a HELOC would meet your needs better than a cash-out refinance. Feel free to contact one of our loan originators if you'd like help with the analysis.
Cash-Flow
Putting all other factors aside, increasing your loan amount increases your payment.
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Future Mortgage Qualification
If getting a cash-out refinance increases your payment, your Debt-to-Income (DTI) would increase. It is possible that your DTI could increase to a point where you cannot afford another home purchase in the future.