Sometimes one mortgage on a house is not enough. One could refer to refinancing as a second mortgage on your home. But that is not entirely accurate. Instead, it would be more precise to describe it as swapping your first mortgage, for a new and improved mortgage.
What exactly do we mean when we talk about refinancing? Well, your new mortgage is a refinance if at least one of the original property owners remains on the deed. So in the case cited above, when a divorce occurs and one of the former spouses wishes to keep the title to the house and the other former spouse wants to be off the mortgage and title, then that's a refinance situation. It's a new mortgage loan, but a refinance since you were already on a mortgage for the property.
When to Refinance
Many home owners took up a fixed rate housing loan when its rate is relatively low. A fixed rate housing loan also gives the home owner a peace of mind, without having to worry about fluctuations. However all good things come to an end. Your fixed rate term expires and it starts to float. For some, the rate really increases and then is usually a likely time to wonder if you should refinance.
You are holding onto a fixed rate housing loan at 3% and it has expired. It increases up to 5%. With the extra 2%, of course you will feel unhappy about it, so you decide that refinancing would be the best option now. However, you will still be paying at a rate of 5% for the next three to six months before your home loan gets refinanced to a lower rate. The money you saved from refinancing can be used towards alternative investments.
Looking at the above example, you will realize that you should start considering refinancing, three to six months before your fixed rate expires. By positioning yourself to refinance earlier, you are effectively saving more money in the long run. This is also known as "lean finance". Of course, what if your housing loan has penalties, or any fall backs and so on? Different people have different terms in their contract. It is better to talk to your mortgage adviser about it, so he or she can help with finding the best options refinancing options for you.
Types of Refinancing
Rate/term refinancing pays off your existing mortgage loan and in addition rolls in closing costs.
Cash out refinancing pays off your existing mortgage loan plus closing costs and, in addition, will take cash out of the equity you already built up that you can then use at your discretion.
Most lenders will not charge a higher rate for a refinance than for a first purchase, so if your lender is doing so, check with your mortgage loan professional for other options. There is no reason to pay more than is necessary.
If you're considering refinancing, then you've already been through the mortgage process once, and you're probably thinking that you don't need any help the second time around. Right? Wrong. There are some definite differences between first and second mortgages, and only your mortgage professional can help you find the one that's right for you.
Let's look at a few of those differences:
First of all, the LTV (loan-to-value) amount is different. Remember that the standard loan to value amount is the result of the loan amount divided by the price being asked for the property. There's no sales price in a refinance (you're not actually selling the house to yourself!), so the number that replaces the sales price is the appraised value.
What typically happens is that an appraiser looks at three comparable properties in your area that have sold recently and uses those numbers to determine the sale value of your home at that point in time. This can either benefit you or work to your disadvantage, depending on how housing values are holding up. Rate/term refinancing allows a 95 percent loan-to-value ratio, while cash-out refinancing allows a 90 percent loan-to-value ratio.
If you're refinancing your home (as opposed to your summer cottage or the place you rent out), you are allowed a three-day "right of rescission," which means that you can cancel the transaction any time in the three days immediately after signing.
If your home was listed for sale within the past year, you will not be able to refinance using Fannie Mae or Freddie Mac; so no "instant" refinancing for a better rate there.
And then there are your personal considerations. If you're going for a lower interest rate, then be sure that you compare the difference in payments (don't include taxes and insurance, which will stay the same). The principal amount will be lower if you've had your home for a long time; it will be higher if you're opting for cash-out refinancing.
Most homeowners look solely at the interest rates when considering refinancing. Don't make that mistake! Closing costs can be significant and may change your mind about that attractive interest rate. If you ask for a good-faith estimate (GFE) of closing costs, you can have some idea of the numbers you're working with. If you think your payment will go down due to lower interest rates, take your GFE and divide it by the payment the difference between your current mortgage loan and your prospective mortgage loan. What number are you left with? That's the number of months it will take you to recoup your closing costs. It is an important thing to know.
Refinancing can make a lot of sense for a lot of homeowners. To see if it makes sense for you, consult your mortgage professional, who can always get you up-to-date and notable information.