Guru Refinance

Introduction to Mortgage Refinancing

2008-10-14T08:25:00.000-07:00

Life is about trading up. Climbing the corporate ladder, upgrading out of that clunker you drove in college, and moving out on your own-all these involve trading in one situation for a better one. You can trade-up mortgages, too.

A mortgage refinance is the process of taking out a new loan, and using the proceeds to pay off your old one. Generally, you'd do this to make a change in the structure of your debt in order to get more money, a lower monthly payment, or a shorter pay-off schedule.

Why refinance?

You'd trade-up your mortgage for the same reason that you'd trade-up your job, car, or living arrangement-because circumstances change. What you need out of a mortgage today may be different from what you needed five years ago. Refinancing can achieve one or more of the following objectives:

1. Lower your monthly payment. You can reduce your monthly payment by refinancing to a lower interest rate. Have market rates dropped since your old mortgage was funded? Has your credit improved? Has your home increased in value? Any one of these happenings could mean that you'd qualify for a lower rate.

2. Shorten your pay-off term. Paying off your mortgage loan in 15 years rather than in 25 can save you tens of thousands of dollars in interest over the life of the loan. If you can afford the higher monthly payment and plan to stay in the home indefinitely, it's well worth it.

3. Optimize your loan structure. Your current loan structure may no longer be suitable for you in the future. Maybe you bought your home with an adjustable-rate mortgage (ARM) and your initial fixed-interest period is about to expire. Perhaps you have a fixed-rate mortgage, but you'd like to take advantage of the more flexible option ARM. Discuss your objectives with your lender to determine the most appropriate loan structure for you.

4. Consolidate your debt. If you're carrying a lot of credit card debt, you can lower your monthly repayments through consolidation. To do this, you'd take out a mortgage loan large enough to pay off all the debts on your cards plus the balance on your old mortgage.

5. Fund large, one-time expenses. You can raise the funds you need by doing what's called a cash-out refinance, where you'd take out a loan that's larger than your current one. As soon as you pay off the old loan, the excess funds can be used to pay for home improvement projects, college tuition, your daughter's wedding, long-term care expenses, etc.

Essentially, your mortgage is a financial tool that might need occasional sharpening. As life throws you new circumstances, trading up that mortgage may be one way to manage change.

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Tax Advantages of Refinancing

2008-10-14T08:21:00.000-07:00

Trading up your job for increased responsibility has some advantages above and beyond a bigger paycheck-maybe a designated parking space, or that coveted corner office. Similarly, a mortgage refinance has a few perks of its own. One of these is the mortgage interest tax deduction.

Saving on taxes

As an existing mortgage borrower, you already know that your mortgage interest is tax deductible. You may also know that you pay far more interest in the early years of a mortgage than you do later on. And the more interest you pay, the higher your deduction. Replacing your current mortgage loan with a refinance might lower your tax liability. And if you intend to use the refinance to consolidate credit card debt, the benefits would be even greater, because you'd be replacing non-deductible credit card interest with tax-deductible mortgage interest.

Tax deductions and refinancing

The IRS designates two types of mortgage debt: home acquisition debt, and home equity debt. Home acquisition debt is what you paid to buy the house. When you refinance, the amount of the new loan used to pay off the old loan qualifies as home acquisition debt. Any amount over that would be home equity debt. The following example will help clarify the point:

• Suppose Jenny owes $200,000 on her mortgage. She takes out a new mortgage for $225,000 and pays off her old mortgage. For tax purposes, $200,000 is home acquisition debt, and the remaining $25,000 is home equity debt.

Interest paid on home acquisition debt is generally tax deductible in its entirety. You can also deduct interest paid on the first $100,000 of home equity debt.

Confused? Don't worry…your tax advisor will happily clear things up. The short of it is that refinancing can help you manage your tax liability.

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Refinance or Second Mortgage?

2008-10-14T08:17:00.000-07:00

When it's time to trade-up your first car, you must select a suitable replacement from the many makes, models, and optional upgrades available. Thankfully, choosing your trade-up mortgage won't be as complicated. But there are still some decisions to be made.

Understanding your options

Let's revisit the common refinancing objectives discussed in Chapter 1:

Lower your monthly payment
Shorten your pay-off term
Optimize your loan structure
Consolidate your debt
Fund large, one-time expenses

The first three can only be accomplished with a refinance. The last two-consolidating debt and funding one-time expenses-can be accomplished with either a refinance or a second mortgage.

To decide between a refinance and a second mortgage, compare your mortgage interest rate with current market rates. If you're paying more than what's available, a refinance will lower your overall interest costs. If you're paying less, a second mortgage might be the better option. When the two rates are roughly comparable, many borrowers prefer the efficiency of a refinance-one loan, one monthly payment. It's also worth noting that refinance loans generally carry lower interest rates than second mortgages.

You cannot, unfortunately, take your new debt for a test drive before signing up. Therein lies the importance of making informed decisions; refinancing your mortgage every year, after all, can get expensive. That leads us to the next topic: closing costs.

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Closing Costs and Refinance Risks

2008-10-14T08:11:00.000-07:00

Remember the last time you moved? You probably incurred some expenses for truck rental, utility hook-ups, moving services, etc. Just like moving, refinancing comes with its own set of one-time expenses, commonly known as closing costs.

All about closing costs

There are a variety of closing costs, but the most common are:
Application Fee
Loan Origination Fee
Discount Points
Appraisal Fee
Title Search Fee
Title Insurance Fee
Prepayment Penalty on Existing Mortgage

The first three listed above are within your lender's control; the others are not. If you have great credit, you might be able to negotiate lower application fees, loan fees, and discount points. Be cautious if a lender offers to cover your closing costs; this may mean you'll be charged a higher interest rate.

Closing costs have been known to change at the last possible moment. Your best protection against unpleasant surprises is to request a written estimate. Also find out what the lender's policy is on closing cost changes; some lenders guarantee their estimated costs, and others don't.

If you're refinancing just to save money, be sure to weigh the closing costs against your monthly savings. If the new loan saves you $50 monthly, but you have to shell out $1,200 in closing costs, it will be two years before you break even.

Risky business

Are there risks involved with refinancing? The short answer is yes. But there are also risks involved in relocating, like noisy neighbors, a house that's a potential money pit, and schools for the kids. Just like these examples, refinancing risks can be managed-if you're prepared. Here are the most common to watch out for:

1. Taking on too much debt. Reputable lenders are trained to find you a mortgage loan program that you can afford. Trust that they know what they're doing, and be honest about your financial situation. Over-burdening yourself with debt could put you on the fast track to bankruptcy.

2. Putting your home at risk of foreclosure. This should be a consideration if you want to consolidate credit card debt into your mortgage. When you consolidate such obligations with a mortgage refinance, your home becomes collateral for debt that was previously unsecured.

3. Increasing your total interest costs. If your old loan has 25 years left until its maturity and you replace it with a new 30-year loan, you'll be incurring interest costs for an extra five years.

In the end, you'll have to evaluate the risks and advantages of refinancing relative to your situation. Since you already have the basic knowledge in your back pocket, that evaluation process should be pretty straightforward. Just stay focused on one goal: a financially stronger you!

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