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Saturday, February 21, 2009

How to Refinance Your Home

By Joseph Ryan

If you've been considering home refinancing but aren't sure about how to proceed, read on.

Home refinancing is an obvious decision if you wish to lower your mortgage payments, reduce your interest costs, or cash out. By "cash out," I mean using your home equity as collateral for a low-cost loan which you can then use to finance other things, like a vacation, a new car, or a child's education.

Here are the three steps in refinancing:

1. Do some Internet research and locate a new mortgage that offers you better terms than your current one.

2. Apply for the better mortgage.

3. Pay off your first mortgage.

Four Caveats

First, note that refinancing is only one of a several ways you can tap into the equity in your home? You may also wish to consider a second mortgage, a home equity loan, or a home equity line of credit. It's a good idea to talk with your broker or lender about these options before going the home refinancing route.

Second, there's often a huge difference in the terms you can get from various brokers and lenders. It's important to not jump too fast. Shop around for your refinancing deal. Yes, you should definitely contact your present lender and give them a chance to keep your business. But also apply through several other lenders as well. Even a seemingly tiny difference in your loan terms (such as a quarter or half point in the interest rate) can amount to a very large difference in your monthly payment or the total interest you pay, or both.

Third, be careful about advertising pitches about refinancing offers that promise unusually good terms. Often, these pitches are applicable only to people with excellent credit scores (700 or above). In any case, home refinancing is a decision you should make based completely on whether it will be financially beneficial to you, not on what deals are out there at any given time.

Fourth, beware of prepayment penalties. Does your present mortgage have a prepayment penalty built in? This could render refinancing uneconomical. Research this out before proceeding. And try to avoid agreeing to any such penalties in your next mortgage.

The Basics of Refinancing

You'll quickly find that refinancing is not a lot different from the experience you had in getting your original mortgage. You'll have to jump through most of the same hoops all over again. Your goal, presumably, is to get a significantly better deal the second time around. For this you'll need one or more of the following:

-A higher income than you had when you applied for your first mortgage -A higher credit score -A substantial build-up of equity in your home -A history of on-time mortgage payments

Unless you can get a better deal, forget it. You will probably incur substantial closing costs in refinancing. Unless you can recoup the costs of refinancing, and do so quickly, it's usually not in your best interest to refinance. (An exception would be if you absolutely need to lower your monthly payments, even if it costs you some money to do so.)

Notice, however -- and this is a point a lot of people miss -- it's not always necessary to get a lower interest rate. You may be able to get a better deal by switching to a different kind of mortgage, such as a variable interest mortgage, or maybe you can extend the term of the mortgage and thereby lower payments.

Understanding the Complexities of Home Refinancing

The Internet can be helpful in understanding and dealing with the complexities of refinancing. Financial calculators are widely available which can help you crunch numbers and quickly figure out how long it will take you to break even -- i.e., recoup your loan costs -- for a given mortgage. You can also check out mortgage rate data nationwide and get referrals to lenders and mortgage brokers nationwide.

One of the better websites for researching refinancing deals is Bankrate.com, which is the Internet's leading financial rate information website. But in addition to any research you do at Bankrate.com, it's also a good idea to discuss your specific situation and financial goals with a reputable lender/broker before signing for a new mortgage, which, after all, is one of the most important decisions of your life.

You'll need to sit down and figure out exactly what terms you must get in order for a home refinancing package to be beneficial to you, given your specific goals. There are, as I said, financial calculators on the Web which can make this reasonably painless. One is at Home Finance.

Assume for example you now have a $200,000, 30-year, fixed-rate mortgage at 7.25 percent. Given this, your monthly payment is (as the financial calculator shows) $1,364.35 and the total interest you'll pay over the term of the loan (30 years) is $291,166.

Now suppose you receive an offer from a lender for a 6.75 percent loan for the same $200,000. That's just a half a point lower than your current mortgage. However, the financial calculator reveals that your monthly payment would drop to $1,297.20 and the total interest you'd pay would drop to $266,992. So you'd save $67.15 per month and also $24,174 in total interest paid in 30 years.

The important question is, Would this amount of savings be worth the time, effort, and cost of refinancing? For most people, probably yes.

Of course, to benefit in this way, it's not necessary that general interest rates decline. You may be able to refinance and obtain a somewhat lower rate even if rates have held steady provided your own credit standing has improved or you've built up a good deal of equity in your property. Another possibility is to take out an adjustable rate mortgage that offers lower rates. This need not involve greater risk. Suppose you plan to move in three years and you can find a mortgage whose interest rate is fixed until the fourth year, at which time the adjustable rate feature kicks in. Then you don't really care -- you're selling the property at that time anyway.

Paperwork You Should Prepare For

Remember the paperwork hassle it was when you took out your first mortgage? The second will be a repeat performance plus one or two additional irritations. But if you prepare the documents you're going to need to get the loan ahead of time, the hassle will be greatly reduced. Here's what you'll need --

- All the following: the current value of your home (the lender will arrange an appraisal to verify your estimate); amount owed on your mortgage; terms of your mortgage, including interest rate; your credit report and credit score

- Pay stubs from at least the last month

- W-2 forms for the past two years (or, alternatively, tax returns for the past two years if you are self-employed)

- Your bank statements for the past two months (three months is even better)

- Investment and IRA account statements for the past two months

- Copies of your present mortgage documents which you received at the closing

Major Points to Remember about Refinancing

-Refinance only if it makes financial sense, given your particular goals. Most people's goals involve one or more of these: obtaining a lower interest rate, shortening or lengthening the duration of the mortgage, cashing out the equity in the property.

-Always shop around for the best deal. The Internet can help a lot here.

-Do the numbers. Use financial calculators to figure out what your break-even point is given various financial scenarios. Bankrate.com is a good source for these tools, as well as much additional information.

-Remember that most refinancing ads are targeting unusually credit-worthy individuals (those with credit scores above 700). Average consumers usually won't qualify for the great deals they're promoting.

-Don't focus entirely on the interest rate or the monthly payment. You must also figure out the fees involved. When comparing the refinancing deals offered by various lenders, always focus on the loan's APR, which reflects the total cost of the loan.

-Today, much or all of your home refinancing-deal comparison shopping can be done via the Internet. It's no longer really necessary to personally visit banks and other lenders, unless you are more comfortable doing it that way.

There are innumerable refinancing businesses on the Internet. Spend some time researching them to find the one likely to be of most benefit to you.

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