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Second Mortgage / HELOC

Compare HELOCs using a margin
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Why margins matter in a HELOC

Let’s take a look at what a margin is and why margins matter in a HELOC (Home Equity Line of Credit).  For the purpose of this post on April 20th, 2018, we’ll be using the HELOC page found here.

HELOC margins range

What we see on the HELOC page is that margins can range quite a bit. In some cases, margins are as low as -1.25.  Other margins show as high as +1.00.  What does this mean when it comes to a HELOC and why is it important?

A real-world HELOC example

Let’s take a look at an analysis for a client that may be interested in obtaining a $100,000 line of credit.  Here it is:

 

In this particular analysis, we will be comparing a “High Margin” and “Lower Margin” line of credit.   In both cases, the Prime Rate is the same because it is not set by the bank.  The margin, on the other hand, is set by the bank offering the line of credit.  This is where you see a range of options.

The High Margin HELOC

The High Margin HELOC shows a margin of 0.50 percent.  When we add this number to the prime rate, we can see that our effective interest rate is 5.25%.  This interest rate will be charged until the prime rate moves up or down.  Any movement in the prime rate will simply move the Interest Rate by the same amount.

In this specific case, a client borrowing $100,000 at a 5.25% rate will need to pay $437.50 each month.

Lower Margin HELOC

When we compare the lower margin line of credit, with a margin of -1.25%, we see that the same client may end up paying just $291.67 per month.  This lower margin results in a savings of nearly $146.00 each month.

2018 Tax Rules may make this more important

Historically, any interest associated with a line of credit could be written off against income. Said another way, a homeowner who obtained a line of credit wasn’t “really” paying the interest rate they were given.  This is because they were able to deduct the interest payments from their earned income and receive a tax refund as a result.

The new tax laws starting in 2018 have changed the laws for HELOCs.  Now, there are many instances where the interest paid towards a HELOC may no longer be tax deductible. Due to this, it is more important than ever to consider savings that may be available from a HELOC with a lower margin.

HELOCs for Wealth Management Clients

Next, let’s examine a $250,000 Home Equity Line of Credit.

 

 

The same margins from above show that a savings of $364.58 is possible between a high margin HELOC and lower margin HELOC.

Cost and Shopping HELOCs

Home Equity Lines of Credit are easy to obtain and the costs to obtain them are either $0 or less than a few hundred dollars.  All else equal, it is important to understand how shopping the margins between HELOCs can have a substantial impact on monthly free cash flow.

If you’d like to evaluate lines of credit in the Philadelphia area, go here.

Home Equity Line
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How does a Home Equity Line Of Credit work?

When it comes to home finance, it pays to know your options. Homeowners looking to access cash often use a Home Equity Line of Credit (HELOC, for short). How a Home Equity Line Of Credit works is different than a traditional mortgage.

Let’s take a look at how they work and what they can do for you.

What is a HELOC?

A HELOC is a common type of second mortgage. Homeowners obtaining a HELOC often have a need for additional cash.  Typical uses are debt consolidation, home remodeling or accessing cash to purchase another property.

A unique structure

HELOCs are different because they have a unique structure. For the first 10 years, the loans are in a draw period.  During the draw period, homeowners can access any portion of the available cash on demand and pay only the interest on the funds in use each month.

During a draw period, homeowners can also pay back funds at any time.  If more cash is needed, the funds which were recently paid back can be accessed again.  In this sense, a HELOC is similar to a credit card.  Different from a credit card, however, HELOCs come with relatively favorable interest rates (only slightly above traditional mortgage rates).

Adjustable rates

HELOCs also come with adjustable rates that follow the prime rate published in the Wall Street Journal. Rates can vary each month and will be impacted by the prime rate and the margin (more on margin in a moment).

When the draw period ends after 10 years, a payback period begins. During the payback period, funds can no longer be accessed from the HELOC. The outstanding balance is converted to a regularly amortizing loan spread over 20 years.  Said another way, the balance is converted to a “normal” 20-year mortgage.  At the start of the payback period, the interest rate is typically fixed and will remain so during the next 20 years.

Shopping a HELOC

Virtually all banks, lenders and credit unions will use the prime rate as the core component of determining the interest rate during the draw period.  This is called the “index.”  A bank will also set a “margin” for the draw period. Banks may offer a promotional margin for an initial period.  For example, a bank may offer “Prime minus 0.50% for 6 months, then Prime plus 0.25% onwards.”

In this case, if the prime rate is currently 5%, the initial rate will be 4.5%.  It is important to note that if prime increases, so will the effective interest rate.  The promotional margin simply reflects a relative adjustment to the published prime rate.

Why a HELOC?

There are several reasons why you may consider a HELOC over a traditional refinance.

Maintain your great interest rate

It is no secret that mortgage interest rates have increased since their historic lows.  While they may still be low, rates in the 3% range aren’t coming back anytime soon.

Homeowners looking to access additional cash may be hesitant to refinance out of their low rate – and rightfully so!  The HELOC, as a second mortgage on the property, is a great option to maintain your first loan and still gain access to cash.  As a second mortgage, the loan operates independently of any first mortgage on a property.

Low costs to obtain

The transaction costs associated with a HELOC are significantly lower than a traditional refinance. The costs of a HELOC are typically limited to an appraisal (around $350).

In contrast to a traditional refinance that involves an appraisal, title charges, lender charges and other fees, HELOCs come out as a far less expensive option.

It is worth noting that many banks offering HELOCs will also require a borrower to open a checking account. If it is not a requirement to obtain a HELOC, it is often a requirement to obtain the promotional rate.

Flexibility

The flexibility provided by a HELOC during the draw period makes them extremely advantageous. In addition to the flexibility of taking money on demand, the flexibility to pay it back and draw again is unique. This is in stark contrast to “closed-ended” mortgages (like your first mortgage) where payments are made and funds cannot be withdrawn.

Flexibility also comes in the form of lower monthly payments.  For most HELOCs, the minimum required payment is equal to the interest accrued during the prior month. In contrast to a traditional mortgage that requires interest and principal, HELOCs provide for a significantly lower payment.

HELOCs also allow some or all of the principal balance to be paid off at any time with no penalty (unless stated otherwise in their terms). This feature allows HELOC borrowers to use them for short-term cash needs – such as cash to purchase and flip a house or buy a car.

Qualifying for a HELOC

Qualifying for a HELOC is similar to most traditional mortgage products.

A homeowner looking to obtain a HELOC will need to have good credit, documented income and some type of assets for reserves. Additionally, banks will require that the total amount borrowed against the home does not exceed 80% (or in some cases 90%) of the home value.

HELOCs can be a flexible way to obtain cash without disrupting a current first mortgage. With mortgage rates inevitably rising in the future, HELOCs will certainly maintain their place as a viable home financing product.

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Paying Off a Home Early: Calculations and Considerations

Should you make a point of paying off a home early? While it would be nice to save on interest and put monthly house payments behind you, early repayment isn’t a one-size-fits-all solution.

About Mortgages

It’s good to get a mortgage. Seriously, without the ability to finance such a large purchase, the real estate market wouldn’t be what it is today and it would instead be controlled by the very well-off.

Banks have been financing real estate since there was real estate to be purchased. Mortgages help fuel the economy in many other areas as well. When people obtain a mortgage to purchase a home, multiple parties benefit.  This can include the appraiser, the real estate agent and even home remodelers. Real estate investors in particular can benefit from the ability to finance investment properties. Mortgage interest is also one of few expenses that are tax deductible.

While the utility of a mortgage is well-defined, it is a debt. So, shouldn’t you strive to pay it off as soon as possible?

Does it make sense to aggressively pay down your mortgage loan? If so, what are the incentives for doing so? Are there any other considerations that need to be made?

If you’re like most homeowners, your monthly mortgage payment is probably your single largest recurring expense. It makes good sense to eliminate that payment and free up cash to be used for other goals such as paying off other debt, saving for college or investing for retirement.

Most mortgage loans today are amortized over 30 years, yet the reality is that few 30-year loans ever actually last that long. Mortgages are refinanced, and homes are sold long before the loans can be paid off.

In the light of this backdrop, let’s take a look at the calculations and considerations of paying a home off early.

Paying Down Pros

If you have ever looked at a mortgage amortization schedule, you understand that far more interest is paid in the early stages of a loan repayment period. If we examine a 30-year loan amount of $300,000 and use a 3.5% rate, we will see that only $472 of the $1,347 monthly payment goes towards principal in the first payment! Nearly twice as much, $875, goes towards interest in this same period.

Mortgage payments are more heavily weighted with interest than principal early on, because the interest rate is applied to the outstanding loan balance. As the mortgage is gradually paid down, the interest rate is applied to an increasingly lower loan amount.

As a result, after five years of making the mortgage payment, the outstanding loan balance has decreased by less than $40,000.  This is despite the fact that more than $80,000 in mortgage payments have been made over that same time period. At the end of five years, the loan balance is $262,234. The interest is an expense and goes to the lender, not toward the homeowner’s equity.

That’s why many borrowers make extra payments on their loans in order to send more to principal sooner and save on interest. Today, there are no prepayment penalties whatsoever on any government-backed or conventional loans. This means that anyone can pay against a mortgage at any time they choose. With an accelerated payoff, homeowner equity is increased. By how much?

Let’s take that same $1,437 payment. By making just one extra payment per year, after five years the loan balance drops to $254,245 instead of $262,234. The one extra payment made each year goes directly toward the loan balance. After 10 years of making one extra payment? The loan balance is $206,611 vs. $224,114. This math can be applied to any property type, whether it be a primary residence, a second home or an investment property. Mortgage amortization works the very same way in all cases.

Paying Down Cons

If paying down a mortgage makes sense, are there ever times when it may not be the best option?

Yes, there are a couple. With rates as low as they have been recently, you could be leveraging your borrowing costs nearly as low as they can go. When a 15-year fixed rate is in the 2.50% range or so, that’s cheap. Instead of paying down your low-interest mortgage, take a look at how your retirement fund is coming along. Yes, getting rid of your mortgage before you retire is the single biggest thing you can do, but can you have the best of both worlds?

When you retire after having devoted your extra funds to paying down the mortgage, without a healthy retirement fund you’ll be “house rich and cash poor.” You may instead be able to find investments now that will provide a higher rate of return over time, or you may want to purchase a rental property with those extra funds.

Feel Good Time

Finally, let’s admit that no longer having a mortgage and still having a safe, secure roof over your head could bring a lot of self-satisfaction. It simply feels good not to have a mortgage payment every month.- and as humans we often makes decisions based on what feels good, not what is mathematically sound.

Also, there’s no mortgage balance to pass along to your heirs when there is no mortgage. It’s an emotional advantage that other retirees may not have as they use their retirement and social security income to make the mortgage payments each month.

Finally, weighing the pros and cons of paying down a mortgage should warrant a meeting with your financial planner or wealth manager. The mortgage is typically your biggest expense and accounts for a large portion of your income. If you are considering paying down your mortgage quickly, take some time out and review your options with someone who can help you see the bigger picture and the long-term benefits and costs of being mortgage free.

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A Day in the Life of a Loan Officer (Video)

Video Transcript: Have you ever wondered what your loan officer does all day?

In a nutshell he or she is working hard on your behalf to close your loan while also managing many other tasks. At times it may feel like they’re doing everything but working on your loan, so keep in mind that loan officers typically only make money when they actually close loans. They want your deal to close.

Your loan officer will change hats constantly throughout their day. They’re a consultant in the morning, a documents processor in the afternoon, a marketer in the evening and a problem solver just about all of the time. One of their toughest jobs is overcoming obstacles associated with documentation requirements and other questions brought up by underwriters. They’re running interference for you all day long, and making a complex process feel a lot more simple than it actually is.

A typical path of working with a loan originator looks like this: You’ll be introduced through MortgageCS or some other way, where you have an opportunity to interact and then exchange information when the time is right. Keep in mind that a good loan officer listens carefully, takes time to understand your complete situation and then develops a proposal that meets your short-term and long-term needs.

A good proposal is much more than the lowest rate being offered. It considers interest rate as well as the length of time you plan to stay in the home, the best strategy for the down payment, the amount of the mortgage, and the estimated closing costs.

Loan Originators stay up to date on program guidelines, complete numerous licensing classes and work hard to set proper expectations that result in delighting their clients. At MortgageCS, loan originators know that a happy customer will leave positive feedback and this will help them build their reputation in the platform – which is about the best marketing a loan officer can get.

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Second Mortgages: What You Need to Know

What is a second mortgage? Isn’t just one mortgage enough? A second mortgage can allow you to access home equity for future purchases and great flexibility. Read on for more about the types available and what each will mean for you.

When most homeowners speak about second mortgages, they’re not talking about an additional mortgage used to buy a home as part of a combo loan, or refinancing an existing loan. They’re referring to a brand-new mortgage that sits in a second lien position behind an existing first mortgage. Second mortgages come in a few different shapes and sizes – and each can address a specific need.

The Home Improvement Loan

A second mortgage can be one loan paid out over time, used to either pull a sum of cash from the equity in your home or perhaps to undertake a home improvement project. For example, a couple who owns a home currently valued at $500,000 has an existing first mortgage balance of $250,000. Their family has begun to grow, and they will soon need another bedroom. They’ve looked into selling their three bedroom home and buying a home with four bedrooms, but that would mean borrowing more and having a larger mortgage than they currently have.

Instead, they decide to add onto their existing home. They work with an architect and a contractor and determine that the addition will cost another $50,000. They add on another $5,000 for “just in case” scenarios, and apply for a second mortgage in the amount of $55,000. The mortgage application is approved, and the lender deposits $55,000 into their bank account. The lender’s guidelines for the second lien required the combined loan to value—the combination of the first and second lien to be placed—was no greater than 80 percent of the current value of the home. This is referred to as the CLTV. The loan this couple received is a fixed-rate second lien with monthly payments stretched out over 15 years, but other terms are available.

Okay, now what if the 80 percent CLTV had posed a problem? What if the property had been worth $400,000 now, rather than $500,000? When improvements are made to a property, the lender can consider the future value of the property when reviewing the appraisal. Let’s say for a moment that adding the fourth bedroom increased the value of the property from $400,000 to $450,000. At the end of construction, the lender would have sent out an inspector who makes sure that that the construction had been completed and that the home’s value had risen to $450,000. In this example, the CLTV would now be 68, well below the 80 percent requirement. This type of arrangement, where a lump sum of cash is provided with a predetermined payment schedule, is referred to as a “closed end” second.

The HELOC Option

A more common type of second lien is a home equity line of credit, or HELOC. A HELOC works much like an everyday credit card, yet the loan is secured by the property. HELOCs also have CLTV requirements that must be met, and they most often use the current market value of the property.

Let’s again assume the CLTV guideline is 80 percent, and consider a home currently appraised at $500,000 with an existing first lien mortgage balance $350,000. Since 80 percent of $500,000 is $400,000, and an existing lien of $350,000 is already in place, a HELOC for $50,000 can be obtained on this property.

Let’s say the couple decides to accept the $50,000 offer. They will now have $50,000 accessible to them just as they would with a credit card, but the interest rates will be substantially lower. Most HELOCS require a minimum amount to be withdrawn, but once repayment is made that balance is immediately reduced.

HELOCS have a draw period, typically the first 10 years, followed by a repayment period that lasts for the remaining term of the loan. Most HELOCs are set for 25 or 30-year terms and have adjustable rates that can fluctuate as rates rise and fall throughout the repayment period.

Subordination

A second lien is more than just another lien placed on a property subsequent and subservient to the first. The second mortgage does not have the same types of legal protection that the first mortgage has, and should the borrowers ever go into default, it’s possible the second lien lender will be left out in the cold, having to deal with the collection process well beyond the foreclosure date.

When a lender is forced to foreclose on a property, the “superior” liens are paid off before any others. A first mortgage used to buy and finance a property is such a lien. Other superior liens are those filed for delinquent property or income taxes. Support payments to an ex-spouse, and child support are superior to a second lien as well. So are mechanic’s liens filed when a contractor builds or makes improvements on a home.

Once all those liens are satisfied after a foreclosure auction, it’s possible there isn’t enough money left to pay off the second lien holder. This is one of the reasons why second lien interest rates will always be higher than what is available for a first lien mortgage used to purchase a home. Simply put, there is greater risk associated with these loans.

There are also times when homeowners fail to pay the second mortgage but are still paying the first mortgage to the satisfaction of the first lien holder. The second lien lender then has the right to foreclose on the property but again, any and all superior liens will be paid off first.

The two types of second liens: closed-end seconds and a HELOCs, are excellent ways to access home equity without having to refinance your entire mortgage to pull out cash, a practice referred to as a “cash-out” refinance. If you plan to use the funds for a specific purpose without the need for future funds, a closed-end second might be the better choice. If you want access to the equity over time with a revolving line of credit, then a HELOC is the best fit for you.

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“My Loan Was Sold!” (Video)

If you know your loan is going to be sold, or if you just found out it was sold, you may be wondering how it could impact your situation.

Watch this short video and find out what you really need to know:

Transcript of Video:

If you know your loan is going to be sold, or if you just found out it was sold, there is no need to panic. Lenders sell all types of loans to other banks on a regular basis. It’s part of their daily business and it’s how they ensure they can continue to make more loans in the future.

In all likelihood, your mortgage will probably change hands several times as banks buy and sell on the secondary market.

So what is this secondary market all about? And how does it impact the terms of your mortgage?

Let’s start with the impact on your loan. There’s no real impact. You have a contract that guarantees the terms of your mortgage, even after it’s sold to another lender. You may have to change the auto-payment settings on your checking account and call a different customer service number, but there won’t be any changes to any of the terms of your agreement.

Now why would a lender sell your loan in the first place? And what’s the secondary market? To answer this question you just need to remember that banks are always working to maximize their profits. And sometimes it’s better for them to sell a loan today, instead of waiting 15 or 30 years to collect small chunks in monthly payments.

Some lenders will sell a mortgage immediately after it closes, often lining up buyers while the loan is still being processed. Other lenders wait until they have a batch of loans. Then they sell them together in a single package, which bankers refer to as a “bulk” sale.

Keep in mind that the secondary mortgage market increases competition, which improves mortgage pricing and terms for you as the borrower. So the fact that your loan can be sold is a very good thing and it shouldn’t be perceived any other way.

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Ace the Mortgage Process with these 7 tips

Buying a home is considered one of the most stressful events in the average person’s life, but it doesn’t have to be that way. Read on for simple steps you can take to avoid unnecessary frustration and delays.

Be Responsive

After you complete your loan application and submit your documentation, the loan officer needs time to review what you have submitted and make sure nothing is missing. He or she might have questions about your paperwork.

For example, your application might state that you make $6,000 per month while your year-to-date pay stub doesn’t match up exactly. Your loan officer or loan processor would then call or email you asking about the discrepancy. The lender can work on other parts of your loan application while awaiting your response, but when there is a question about income, the lender can only go so far. The longer you delay your response, the longer it will take the lender to process your application. You might even miss your settlement date!

When asked to clarify something about your application, respond quickly and clearly. If you have documentation to support your claim, always send it to your loan officer.

Review Your Credit In Advance

It’s easier than ever these days to get a free copy of your credit report. You really should review it annually, looking for any errors. Many credit card companies today offer a free credit score service, and the three main credit repositories: Equifax, Experian and TransUnion have also created a portal at annualcreditreport.com, where you can view and print your credit report for free.

When reviewing these reports, don’t focus exclusively on the score as it won’t be the very same one the mortgage company receives (but it should be close). What you’re looking for are mistakes because unfortunately, credit reports can often contain errors. Someone else’s bad credit might pop up on your report, or a creditor could mistakenly report a late payment. Don’t be caught off guard when your loan officer calls and tells you something on your credit report is causing problems – be proactive to preserve your credit profile.

Gather Your Financials

When you submit a completed loan application, you’ll also be asked to provide some documentation that will verify certain aspects of your loan. Prepare these in advance so you won’t have to worry about scrambling for paperwork while the clock is ticking on a 30-day closing. Gather your:

  • Most recent pay stubs covering the last 30 days
  • Two most recent W2 forms from your employer(s)
  • Most recent bank statements (all pages) covering the past 60 days
  • Homeowners insurance information
  • Two most recent annual federal income tax returns
  • A year-to-date profit and loss statement as well as business bank statements if self-employed

Note: When using a digital mortgage platform, you’ll still need information contained on these documents – or should review them to eliminate any surprises.

Lookout For New Info

Just before your settlement date and the signing of your loan papers, the lender will make a final pass over your application to be sure the documentation in the file is current.  This includes a review of recent pay stubs, retirement account documents, bank statements and other items. At this time, if there is a more recent document available, the lender will ask for it – and it will feel like a bit of an emergency.

To avoid this issue, always provide updated documents to your lender right when you receive them. You should also save a copy of all messages sent – so you can easily resend if needed.

Don’t Make Changes

This is one of the most common requests/gripes from loan officers when accepting a loan application because the consequences can be catastrophic.

Here are the “Don’ts” to follow when your loan is in process:

  • Don’t take out another credit account.
  • Don’t get a new phone
  • Don’t miss a payment on anything
  • Don’t ask a credit card company for a credit line increase
  • Don’t accept a new credit card offer
  • Don’t co-sign on a loan
  • Don’t buy or lease a car
  • Don’t change jobs
  • Don’t deposit cash into your savings or checking account
  • Don’t withdraw cash from your savings or checking account
  • Don’t change at all from what appears on your mortgage loan application.

Here is the list of “To Do” to follow when your loan is in process:

  • Follow the list above

Ask Questions

One of the main responsibilities of your loan officer is to ensure you have a clear understanding of the process, especially as it relates to closing costs and your interest rate. When you receive your initial offers or cost estimate, review the prospective charges with your loan officer line item by line item and get a clear picture of not just the charge, but why it’s being ordered.

For example, all transactions require a certified Flood Certificate stating whether or not the property is located in a flood zone. Even if your property is nowhere near water or flooding, you’ll still need this in your file. It’s best to ask questions long before you get to the closing table.

Follow Your Lender’s Lead

If you could to look inside your mortgage company while your loan application is being documented and verified, it would probably look like people were spinning plates.

Mortgage lenders must document every aspect of your application and work with multiple other professionals to complete the documentation process in order to get your loan to the underwriting department, which then approves loan. We touched on this earlier, but it can’t be stressed enough: follow the advice of your loan officer, and work with your loan processor to provide requested information as soon as possible.

Mortgage companies do one thing and one thing only: they process mortgage loans. They know exactly what documentation is required and when, so follow the mortgage company’s lead.

If you follow these simple steps, you will be your loan officer’s favorite borrower but more importantly, your loan approval will be easy and stress-free. It all boils down to communication. Talk, ask questions and work hand-in-hand and with your mortgage company to ensure a smooth and simple transition into home ownership.

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When to Refinance, and When NOT To

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Interest rates have been in their narrow range for some time now, after hitting record lows in late 2012. The average 30 year fixed rate hit 3.31% that year according to Freddie Mac’s weekly mortgage rate survey.

You may not be able to find a 3.31% rate today (at least without paying additional fees), but you can still get very close considering the recent few decades of interest rates. Many homeowners have taken advantage of lower rates and refinanced their mortgages to enjoy lower monthly payments, but there are still more who, for whatever reason, haven’t decided whether or not a refinance makes sense.

There are ways to know whether a refinance is a good idea, and it’s not always about the interest rate. Here are some basics to keep in mind when considering a new mortgage:

Interest Rate & Payment

This is the most common reason people refinance. When mortgage rates fall, homeowners soon see solicitations from mortgage lenders announcing the new opportunity to lower their monthly payments. While that certainly makes sense in many cases, it’s not the right solution for everyone, every time. You may have heard it’s a good idea to refinance if rates are say, 1.00% below what you currently have, but the rate is only part of the equation. If you have a 30-year fixed rate of 5.00% and rates fall to 4.00%, then that so-called “rule of thumb” would kick in. But that’s not the only consideration when evaluating a possible refinance.

Instead, you must first weigh the difference in monthly payments compared against the fees associated with getting the new mortgage, then determine how long it would take to recover those closing costs. Let’s look at a basic example. Let us suppose that you have a mortgage balance of $200,000 and a 30-year fixed rate at 4.00%. That puts your current monthly principal and interest payment at $954 per month.

Now imagine interest rates have fallen to 3.25%. The new monthly payment would fall to $870, for a monthly savings of $84 each month. That’s an attractive number, but how much will it cost to get that lower rate? Let’s say that lender fees are $1,000, and other third party charges add up to $3,000 for a $4,000 total. If you divide the monthly savings into the closing costs you get 47.62, or almost 48 months to recover those fees with the lower payment. Is that too long?

Possibly. Some think a recovery term of two to three years makes the most sense, and if you’re going to own the property for at least that long, then a refinance might be a good idea. When refinancing a mortgage because rates are lower, you must also consider the costs involved.

Note: It is also important to consider the costs of re-amortizing (or starting over) on your loan term. These details are not covered in this particular article –however here is a brief: If you are two years into a 30-year loan and refinance into another 30-year loan, you are resetting the 30-year period, meaning you have 30 more years to pay your new amount compared to just 28 years of paying the older mortgage payment.

To reduce costs, it is a popular option to obtain a lender credit at the time of closing. Mortgage companies are typically willing to increase your interest rate in exchange for lower closing costs. Using the example from above, if you increased the new rate from 3.25% to 3.50%, the monthly payment would still be $56 lower. At the same time, the lender would provide you with a credit of $2,000, or 1% of the loan amount. In this instance, the time it would take to recover your closing costs will be under three years, or 35 months- certainly a more attractive option.

If you are wondering how this works, you are not alone. In the same fashion that you can lower a 30-year fixed rate by paying discount points, you can also select to increase your interest rate and have the lender pay some of your costs in the form of a lender credit. Mortgage lenders have no preference on which option you take – so explore your options before making a final decision.

Changing Loan Terms

Another popular reason to refinance is to shorten the term of an existing loan. Reducing the term of a mortgage loan saves a considerable amount of interest, yet it also typically increases the monthly payment. Most borrowers opt for a 30-year fixed mortgage due to the lower monthly payments, even though it will take twice as long to completely pay off the balance.

Continuing our example from above, a $200,000 mortgage with a 30-year fixed rate of 3.50% will require a payment of $898 while a 15-year loan at 3.25% will require a payment of $1,405 per month. While the difference in monthly payment may be significant, so is the impact on how quickly the loan is paid down. Just five years into these loans, the principal balance remaining on the 15-year loan is nearly $36,000 lower, when compared to the 30-year loan option ($179,394 on the 30-year loan compared to $143,814 on the-15 year).

Sometimes the jump in payment between a 30-year fixed rate to a 15-year is too great, so much so that a borrower may not qualify for the shorter-term loan. Fortunately, there are other options that many may not know about. Mortgage lenders typically also offer fixed-rate terms of 10, 20 and 25 years. Compare these options if you want to shorten the term without dramatically increasing your monthly payment.

ARM to Fixed

Adjustable rate mortgages, or ARMs, offer lower introductory rates and can be attractive for buyers who don’t expect to finance a property for the long haul. Most ARM loans begin with fixed rates, which are in place for a period of time ranging between three to 10 years. After this fixed period, the interest rate can vary on an annual or semi-annual basis.

Refinancing an ARM or a hybrid takes the uncertainty out of future mortgage payments. ARMs can offer lower, “teaser” rates compared to fixed-rate products, but because they can and will change at some point, if fixed rates are low and the home owner intends to own the property for the foreseeable future, it is likely a wise decision to refinance.

When NOT to Refinance

Cashing Out

One of the worst reasons to refinance a mortgage is to pull out cash. Refinancing an existing mortgage requires closing costs, but borrowers typically pay for these with the equity in their home, while simultaneously putting some extra cash in the bank or using it for other purposes.

Refinancing for the sole reason of pulling out cash is a bad, expensive idea. If you are in need of extra cash, a home equity line of credit or second mortgage may be a better option as they are much less expensive overall.

Wasted Interest

Let’s review the $200,000 30-year loan at 3.50% from above. After five years, the amount of interest paid is $33,279. At first glance it seems like a good idea to refinance and lower the monthly payments if possible. By refinancing into another 30-year loan, you’ve lost that $33,279 and extended your loan back to its original loan term, effectively changing your original 30-year loan into a 35-year mortgage!

Important Note: In some instances, particularly those that involve low mortgage interest rates and a long-term outlook, a refinance into a longer-term loan could be an advanced and strategic financial planning decision. This is not intended to be financial advice – however, each situation is unique and you should discuss this option with your advisor in detail.

While the majority of homeowners will consider interest rate as the guiding light towards the appropriateness of a refinance, there are many other considerations worth evaluating. Take your time and consider both the short term and longer-term impacts of your refinance decision.