Monday, July 20, 2009

When to refinance?

How did the mortgage process get so complicated? Products have become so confusing in recent years, it's hard to understand how they actually work. With products like, negative amortization, 7/1 ARM, interest only, reverse mortgage, etc. It's hard to know what you're getting yourself into and what changes will occur at a future date.

Fortunately, it doesn't have to be this difficult! Mortgage rates are near historic lows and good old fashioned fixed mortgage (15 or 30 years) will answer a lot of prayers for first time home buyers and/or individuals looking to refinance.

When it comes to refinancing, there are a number of reasons to do so:

  1. Lower Your Monthly Payment - This is the most common reason for getting a new mortgage. Reducing your interest rate and thus your monthly payment(s) makes good economic sense. Most people will follow the "2%" rule of thumb, but this doesn't always apply. The bigger the mortgage, the less of a change you need to make it worth your while. A big mortgage will change the numbers. For example, a 750,000 mortgage (30 year fixed @ 6%) requires a monthly payment of $4,497. Simply reducing the rate to 5.5% lowers your payment to $4,258 (a savings of $339 per month or $2,863 per year).

  2. Consolidate Debt - Bundling debt into one payment can make sense for some people. Should you carry credit card debt that is not paid in full each month, the interest rate could be significantly higher than that of a mortgage. Some rates are now in the 20% range. I'll be the first to admit putting your HDTV on a mortgage turns a short term purchase into a 30 year commitment. The amount of money you will pay for your television will be significantly higher. But, if monthly cash flow is a concern, this could be a way of reducing monthly expenses. Any savings could be applied to the principal on your mortgage.

  3. Borrow Home Equity - Owning a home is expensive. Sometimes refinancing and using some of your equity allows you to upgrade a kitchen or a bathroom. It would be ideal to pay cash for this renovation, but coming up with $10,000- $50,000 isn't an option. Some parents also use their home to finance kids college or a purchase of a new car. As a Financial Advisor, I recommend against this as college and cars should be separate goals with different time frames. However, using your home to finance these items is becoming more common. Also, the interest can be tax deductible.

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