Mortgage refinancing is the replacement of one secured loan with another loan (usually with better or safer terms, such as a fixed rate as opposed an adjustable one), using as collateral the same property.
The new loan can be provided by the same lender that provided the original loan or by another lender. The proceeds from the new loan are used to repay the original loan. There is no restriction that the amount obtained through the new loan must be equal to the balance of the original loan; actually it can be larger, if there has been some equity build up since the original loan was obtained by the borrower and if the owner desires to do so. Depending on the circumstances, the borrower may reap the following benefits from mortgage refinancing.
Get a Lower Interest Rate and Reduce Monthly Payment
Interest rates are rarely constant; they move up and they move down subject to national and international forces. So when interest rates are decreasing, many homebuyers and borrowers that mortgaged their properties find themselves holding loans at rates higher than the market rates. In such a case mortgage refinancing, that is, taking a new loan at lower market rate will allow them to reduce their mortgage payment (assuming that all the other terms of the loan remain the same).
Tap on Accumulated Equity
If the loan is not an interest-only loan (which is the case for a typical home mortgage) the owner accumulates equity as the loan is repaid through time. Equity accumulation (which is defined as the repayment of the principal of the loan) is very slow in the early years and accelerates as time goes by. However, the owner may accumulate equity faster, if house or property prices in the local market are rising. For example, if local housing values are rising by 5% per year, the dollar amount corresponding to such an increase will represent a pure equity gain for the owner. Refinancing can allow the owner to tap into this additional equity that is gained both through repayment of the loan principal and through value appreciation.
Reduce the Risk of your Loan by Switching from an Adjustable-Rate to a Fixed-Rate Mortgage
Adjustable rates are typically lower than fixed rates and many borrowers go for them, especially in periods during which interest rates are stable or/and low. However, when interest rates start rising these loans are becoming very risky for the borrower as the monthly mortgage payment starts rising too. During such times, refinancing allows the borrower to get a new loan at a fixed rate and repay the adjustable rate mortgage (ARM), thus ensuring that his/her monthly payment will remain stable independently of fluctuations in the economic environment. If the term of the loan remains the same as that of the original adjustable mortgage loan, the borrower’s monthly payment will increase, as the fixed rate will be higher than the adjustable rate. The borrower though may be able to keep the mortgage payment roughly at the same level if the refinancing loan has a longer term than the original ARM. If we keep the interest rate constant, an increase in the term of the loan results in a lower monthly payment. Thus, a longer term may offset the increase in the monthly payment due to the increase in the interest rate.
Eliminate Private Mortgage Insurance Fees
If the borrower is unable to make a down payment equal to the 20 percent of the value of the property mortgaged he/she is required to buy private mortgage insurance. If at the time the refinancing loan is obtained the borrower’s equity has reached the 20% of the value of the property through principal repayment and value appreciation, refinancing can allow the elimination of the fees for such an insurance.
Restructure the Terms of the Loan so that they Better Fit your Circumstances Mortgage refinancing maybe pursued in order to change some of the terms of the loan in a way that better fit one's circumstances. For example, the property owner may have the ability to repay the loan faster, thus paying lower interest overall. In such a case, the owner may pursue mortgage refinancing in order to reduce the term of the loan from 30 years to 15 years. Many refinancing requests though have the opposite purpose (increasing the term and reducing the mortgage payment).
Mortgage Refinancing Process
The mortgage refinance process does not differ from the regular mortgage financing process. The borrower needs to find a lender, have the property appraised, fill a loan application, and provide all the required documentation for verificaiton of his/her income and assets. Once the loan is processed and the refinance mortgage funds are available, the remaining balance of the old mortgage, as well as any prepayment penalties, will be paid off. Any remaining funds from the new loan will be transferred to the borrower. As is the case for a regular mortgage, the borrower will be charged with closing costs for mortgage refinancing. The refinance lender may be the same lender that made the original loan for the acquisition of the property or a different lender.
Mortgage Refinancing Costs
Mortgage refinancing fees differ from country to country and from lender to lender. In the US, according to the Federal Reserve Board (FRB), it is not uncommon to pay 3 percent to 6 percent of the outstanding principal in mortgage refinancing fees, in addition to any repayment penalties or other costs that the borrower may incur for paying off the existing mortgage. Some typical fees involved in mortgage refinancing in the US include the following:
1. Application fee, which covers the initial processing costs for processing the loan request carrying out a credit check, and ranges from $75 to $300 (FRB)
2. Loan origination fee, which is the fee charged by the broker or lender for the assessment and preparation of the requested mortgage loan. The cost ranges from 0% to 1.5% of the loan principal (FRB).
3. Points, which may represent loan-discount points, points. These represent a one-time fee charged in exchange of reducing the interest rate of the loan. Some lenders and brokers may also charge points to earn money on the loan. Points charged range from 0% to 3% of the loan principal (FRB).
4. Appraisal fee, for the appraisal of the property to be used as collateral. This fee sometimes maybe included as part of the application fee. If there is a recent appraisal from a reliable source the lender may waive the requirement for a new appraisal. The appraisal fee ranges from $300 to $700 (FRB).
5. Inspection fee, in case the lender requires a termite inspection and an evaluation of the structural condition of the property. The state may require additional, specific inspections. Inspection fee ranges from $175 to $350 (FRB).
6. Attorney review/closing fee, which is usually charged by the lender for the services of the lawyer or company that carries out the closing for the lender. These fees range from $500 to $1,000 (FRB).
7. Homeowner insurance, which is required by the lender as a protection form the event that house is destroyed. The annual cost ranges from $300 to $1,000 (FRB).
8. FHA, RDS, or VA fees or PMI, which apply for loans insured by the Federal Housing Administration (FHA) or the Rural Development Services (RDS) or loans guaranteed by the Department of Veterans Affairs (VA). This fee applies also to conventional loans insured by private mortgage insurance (PMI). This is usually the case if the loan is more than 80% of the value of the property.
9. Title search and title insurance fees, which cover the cost of searching for the property title and any existing liens that burden the property. The title insurance covers the lender against any errors in the findings of the title search. These fees range from $700 to $900 (FRB).
Some lenders often offer “no-cost” refinancing in which the closing costs are covered by the lender, but the borrower is charged a higher interest rate instead. Another no-cost refinancing arrangement is to include the refinancing fees in the loan principal, which means that the borrower will repay these fees with interest.
Search Our Over 300-Page Website!
Related Posts
Types of Mortgage Loans
Using Borrowed Funds to Finance Property Investments
Mortgage Loan Amortization
Adjustable Rate Mortgages
Blanket Mortgages
Wraparound Mortgages
Second Mortgages
Mortgage Constant
Monthly Mortgage Payment
Leveraged IRR Calculation
Return from Mortgage Refinancing to Mortgage Financing
Copyright 2006,2007 All Rights Reserved.
Published with Permission of Author.
No part of this publication may be copied or reprinted
without the express written permission of the Author and Property-Investing.org
|
