Refinancing is done for many different reason. The motivation behind a refinance can be any of the following:
- Lower interest rate
- Lower payment
- Shorten term, like going from a 30 year fixed to a 15 year fixed
- Change program from a adjustable rate mortgage to a fixed rate mortgage.
- Combine a first and second/equity line into one new loan
- Pull cash out for debt consolidation
- Pull cash out for home improvements or a remodel
- Drop mortgage insurance
Interest rates change daily, and in many cases lenders will issue several interest rate changes within the same day. Many lenders offer “no cost” refinancing, while others will advertise extremely low interest rates that come with big fees. Which is better?
What is a “No Cost” refinance?
A “no cost” refinance occurs when a borrower chooses an interest rate that is a little higher than the “PAR” or 0 point rate.
By taking a higher interest rate the lender is able to offer a rebate, yield spread premium, or lender credit, which can be used to offset the closing costs associated with a loan.
The great thing about having the closing costs covered by the lender credit is that the “breakeven” for the refinance is immediate.
For example, let’s assume that Johnny is refinancing a $400,000 loan. He currently has a rate of 5%, which he got 32 months prior when is loan amount was $417,000. His payment is $2,238. A lender is now offering a “no cost” refinance at a rate of 4.5% (4.5% APR – since all closing costs are covered).
The payment on a $400,000 30 year fixed rate at 4.5% is $2,026. He would save $211 per month and have no closing costs financed into the loan. He breaks even the day the loan closes.
The other option is he could get a rate of 4.25% ( 4.375 APR). Even at 0 points he would still have approximately $3,800 in closing costs added to the loan. His payment would be $1,986, or $252 less than his current payment. Because he had closing costs, the break even for the refinance would be 15 months ($3,800 divided by $252 savings = 15 months).
Another good option would be to consider a No Cost 25 year fixed.
At 4.5% the payment would be $2,223. With nothing added to the loan, Johnny could take 28 months off his loan (he goes from having 328 months remaining to only 300 months remaining, saving 28 mortgage payment, or over $62,000.) Many people with FHA loans want to eliminate the monthly mortgage insurance.
- FHA has fairly restrictive rules regarding the removal of mortgage insurance, making it much easier and quicker to just refinance out of FHA and into a loan program with no mortgage insurance.
- VA is also a great option for those that are eligible. VA allows for a cash out refinance to 100% of the property value. For those that already have a VA loan, the IRRRL, or Interest Rate Reduction Refinance Loan, offers Veterans an easy way to lower their rate and payment. There is no appraisal and no qualifying. Truly the easiest refinance program available.
How Do You Figure Out if Refinancing Makes Sense?
Refinancing does not always makes sense (of course) So how do you know when it does make sense? It helps if you have someone you can trust in the mortgage business. If you live in Orange County, then checking with an Orange County loan officer should be your first move. And I always like to throw in there, “an experienced” loan officer. You don’t want someone who is going to just throw a rate at you, but someone who will actually do some analysis. It’s not too much to ask for a Side by Side Analysis of your loan options as they compare to your current loan. And you definitely don’t want someone who is going to pressure you into something you don’t want to do.