Refinancing

Refinancing seems easy to understand but is it really?

Here’s a lengthy refinancing definition so you can make up your mind once and for all regarding the exquisiteness of the refinancing concept:

Say you got a mortgage loan years ago and now you apply for a second mortgage; whether the second loan was gotten to pay off the existing mortgage or to gain access to the existing equity in the home, this act is called refinancing.

Creditors may want to refinance one's obligations if he or she cannot satisfy the original payment or if interest rates have fallen since a borrower took out the loan. For example, to determine if refinancing is beneficial it depends on the refinancing costs including closing costs and the time needed to recover those costs through low mortgage payments. An approximation of the closing costs is using the costs of refinancing (3% to 6% of the outstanding principal) and multiply it by the amount of the loan.

The best way to measure the costs and gains from doing a refinancing is to compare all the costs of the existing mortgage and a new mortgage over a future period. The period should be your best guess as to how long you will have the new mortgage. If the total costs are lower with the new mortgage, you should try refinancing.

Loan officers often calculate a break-even period by dividing the cost of the loan by the reduction in the monthly mortgage payment. For example, if it costs $4,000 to refinance and the monthly payment falls by $200, the break-even would be 20 months. This rule of thumb does not take account of differences in how rapidly you pay down the balance of the new loan as opposed to the old one, it does not allow for differences in tax savings (which depend on the borrower's tax bracket), and it ignores differences in lost interest on upfront and monthly payments. So it’s best to avoid this common rule-of-thumb.

Additionally, lenders ordinarily allow refinancers to fold the settlement costs into the loan amount without classifying it as a 'cash-out' . For example, if the balance on the old loan is $100,000 and settlement costs including the lender's fees are $3,750, the new loan could be for $103,750. Refinancing the settlement costs, however, reduces the gains from refinancing because the borrower must pay interest on the costs at the mortgage rate. Financing the costs, furthermore, can flip the loan amount above 80% of property value, which triggers mortgage insurance. If the borrower is already paying mortgage insurance, it can raise the premium.

Refinancing with the Current Lender

Borrowers interested in refinancing face the problem of whether they approach their current mortgagee, go to another loan provider or both. Here are the pros and cons of a refinancing with the institution that gave you the original loan.

The Pros:

Perhaps the major reason people approach their current Lender when refinancing is that it is convenient. Seems like a lazy reason, but it’s not. When dealing with the original lender, you are spared having to decide who and where to shop. Furthermore, your existing mortgagee has immediate access to your record, where other lenders would have to investigate. There is comfort in being known and a belief that this should earn them special treatment. There is some validity to this belief. But of course, that psychology only applies to people that have a good payment record. It better be your case!

With that confidence and predictability, the mortgagee might offer lower settlement costs than a new lender. If the payment record has been good, the current mortgagee may forgo a credit report, property appraisal, title search, and other risk control procedures that are otherwise mandatory on new loans. This is strictly up to the mortgagee. The potential for lower settlement costs is least when the current lender is neither the originating lender nor the current owner. This is a fairly common situation that arises when the contract to service the loan is sold. In this case, the lender may not be in a position to use all of the streamlined refinancing procedures because its files do not contain some of the information those procedures require, such as the original appraisal report.

The Cons:

The major argument against refinancing with your current lender is that that lender may not give you the market price. It will try to minimize its loss by taking advantage of your preference for staying put and your reluctance to shop the market. Any settlement cost benefits your current mortgagee can offer that other mortgagees cannot, may serve to draw attention away from the fact that the rate and points offered are not competitive. Above-market offers are especially likely if the lender takes the initiative in soliciting its own customers. Mortgagees who do that are likely to base their offer on the borrower's existing rate. For example, in a 5% market, the borrower with a 7% loan might be offered 6% while a borrower with a 6% loan (but who is otherwise identical) might be offered 5.5%. The objective is to provide a saving over the existing loan that is attractive enough to discourage the borrower from looking elsewhere. This way, the lender gives up as little as possible.