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Is Refinancing Right for You?

Remar Sutton, DCU StreetWise National Spokesperson
Are you tempted to refinance with interest rates at historic lows? Or are your loan payments stretching your budget? How do you know if refinancing is right for you? This month's review looks at reasons why now may be a good time to refinance your mortgage or other loans.
Is refinancing right for your circumstances?
  • Is your loan's interest rate higher than current loan rates? Do you have equity in your house or property (that means, do you owe less than the current value of your property)? Are you current on your loan payments? If you can answer yes to these questions, then you may wish to consider refinancing. This is true even if you are concerned that the current payments are going to strain your budget.
  • Have you fallen behind in making your mortgage payments? Are you having financial difficulties in other ways, perhaps in paying other bills or loans? If you answer yes to either of these questions, then conventional refinancing is not an option for you. If you are not already discussing your problem with your lender, the time to do that is now. Some lenders may consider loan modifications as one option to help delinquent and struggling borrowers. If your loan is with DCU, they encourage you to call right away. Even if you have other lenders, DCU's Financial Wellness and Recovery program offers assistance to help members deal with debt and credit problems.
Is the time right to refinance?
Before visiting a lender or filling out an application, ask yourself these questions.
How long do you plan to stay in the house? You will need to stay in the house long enough to break even on the cost of refinancing. This means you need to know how many months it will take to recoup the refinancing costs before you actually benefit from the lower interest rate. This break-even calculation example from the Federal Reserve can help you determine your break-even period.
Does your current mortgage have a prepayment penalty? If so, you'll need to add the amount of the penalty to your break-even calculations.
How many years are left on your current mortgage? In the early years of a typical mortgage, a greater percentage of the monthly payment is applied to interest not to the loan principal. The longer you hold a mortgage, the more the percentage of your payment applied to the principal increases, while the percentage applied to interest decreases. When you refinance and extend the loan term, more of your monthly payment will be applied to interest. Compare the total cost of your current loan and the proposed new loan (including all interest) to see which saves you money. For example, if you extend the new loan term beyond your remaining loan term (something lenders may suggest), then you may have a lower payment but pay more interest in total because of the extended term. Use DCU's refinancing comparison calculator to compare terms of different loan options.
Determine your equity in your home.
Whether you're eligible to refinance will be determined, in part, by the current value of your home and how much you still owe on it. So, before you apply for any refinance loans that require an outlay of your cash, such as an application fee, you should get an idea of the current value of your home. Use several of the following types of information to get a “ball-park” estimate:
  • Recent sales of comparable properties. In many states, this information can be found online. Start with the website of your local government property appraiser's office. Locate yours at www.statelocalgov.net.
  • Current listings of comparable homes for sale. To find the multiple listing service for the area, put the area name and MLS in your favorite search engine.
  • Estimates from local real estate brokers or appraisers.
  • Home valuation web sites such as Zillow.com.
  • Local government property tax valuations. Many of these offices now have this information online. A caution: the basis for tax valuations or assessments varies from state to state and can vary widely within a state. Even in states where regulations require fair market value assessments, typical assessments may be well below what a homeowner could sell the home for–or, in the current depressed real estate market, tax valuations might be higher than sale value.
One more option is an appraisal by a licensed appraiser. It will cost you money but should give you the most up-to-date picture. It is the most accurate, but since you will probably be paying the lender for an appraisal anyway, we don't recommend you take this step.
Experts recommend that you use multiple sources to generate an estimate due to the timeliness of the information from some of the sources.
Once you've generated your estimate, subtract what you currently owe from it. The result represents the equity you have in the house.
To qualify for refinancing, you may need equity equal to at least 3.5% of the property value (for an FHA loan). Depending on the lender, your equity may need to be 5%, 10%, or higher. DCU requires 5% on conforming loans and 10% on jumbo loans.
If you don't have the required equity, you may still be able to refinance if you can pay down the principal to reach the required equity.
How does the refinancing process work?
When you refinance your mortgage, you are paying off your existing mortgage and creating a new mortgage. The refinancing process is very similar to the process of acquiring the original loan. The same is true if you are refinancing a vehicle.
To refinance a mortgage, you will have to fill out an application and, depending upon the lender, you may have to pay an upfront application fee. The lender will look at your income and assets, credit score, other debts, the current value of the property, how much you currently owe on the property, and how much you want to borrow.
A key criteria for mortgages is the loan-to-value (LTV) ratio. The LTV ratio is the relationship of the property's appraised value to the total amount of the loan. In order for you to receive a new mortgage, the LTV ratio must conform to the lender's guidelines.
Beyond an application fee, there are also other fees and costs typically associated with refinancing a mortgage. These can include a loan origination fee, points, appraisal fee, survey fee, title search and title insurance, and others. Chapter 6 of the StreetWise Mortgage Guide has more information about these and related closing costs.
If a lender offers “no-cost” refinancing, make sure you understand what is meant by the term. If the lender is paying the closing costs, then it is truly a no-cost loan to you. If the refinancing fees are rolled into your new mortgage, even though you don't have to pay the costs at closing, you'll end up paying the costs plus interest on that amount over the life of the loan.
Refinancing your mortgage to reduce your payment
You may be considering refinancing if your mortgage is too expensive. For many people, this situation arose when their Adjustable Rate Mortgage (ARM) reset. For others, changes occurred in their financial situation.
You can reduce your payment by refinancing the remaining amount you owe at a lower interest rate at a term equal to relatively near the remaining term on your current loan.
Another option is to extend your loan term. The drawback to this option, is that you'll increase the amount of interest you'll pay over the life of the loan. Your equity will build more slowly.
If you don't qualify for refinancing, talk to DCU about your options. You also might want to check out DCU's Financial Wellness and Recovery program.
Refinancing your mortgage to get a lower rate
If interest rates have dropped, then you can refinance your mortgage at a lower rate.
Another option to get a lower rate is to decrease the mortgage term. By reducing the term, even though you may have a higher payment, you may build equity more quickly and reduce the interest paid over the course of the loan.
What about the government's Making Home Affordable plan?
The Making Home Affordable plan has two components, loan modification and loan refinancing.
Loan refinancing
The loan refinancing program helps homeowners who are current on their mortgages but can't refinance because their homes have decreased in value. To be eligible for this program, the homeowner must meet the following criteria:
  • owner occupant of a one to four unit home
  • must not have been more than 30 days late on your mortgage in the last twelve months
  • first mortgage must be owned or guaranteed by Fannie Mae or Freddie Mac
  • the loan amount must be no more than 105% of the current value of the home
Loan modification
The loan modification program is designed to help homeowners who are struggling with their mortgage payments reduce their mortgage payments to a level that they can afford over the long term. It is not limited to Fannie Mae or Freddie Mac loans. To be eligible for this program, the homeowner must meet the following criteria:
  • owner occupant of a one to four unit home
  • the unpaid principal balance must be less than or equal to $729,750 for one unit properties (there is a higher limit for two to four unit properties.
  • the loan must have been originated on or before January 1, 2009
  • their mortgage payment (including taxes, insurance, and homeowners associate dues) is more than 31% of their gross (pre-tax) monthly income
  • their mortgage payment is not affordable perhaps because of ARM reset, reduction in income, or increase in expenses.
To see if you are among the 7 to 9 million homeowners who may be able to benefit from either of the Making Home Affordable program, use these self-assessment tools.
If you determine that you might qualify, the next step is to talk with your mortgage servicer or a housing counselor. If DCU holds your mortgage, call them at 800.328.8797. You should have the following information available before you call.
  • Information about your (or your household) monthly gross (pre-tax) income such as recent pay stubs or other documentation of your income
  • Information about your first mortgage such as the monthly mortgage statement.
  • Information about any second mortgages or home equity line of credits you may have.
  • Your most recent income tax returns.
  • Account balances and monthly minimum payments for all your credit cards.
  • Account balances and monthly payments for any car payments, student loans, and any other debt you may have.
  • Information about any savings or other assets.
If you are interested in these programs, call DCU at 800.328.8797.
Refinancing other loans
Mortgages aren't the only loans that you can refinance. If you have an auto loan, you may be able to refinance it to save a bundle or lower your payments. If you didn't get your car loan from DCU, check out DCU's Second Chance Auto Loan program. It may be advantageous to refinance other loans as well such as for boats or RVs.
A better bottom line
The purpose of refinancing is to save money long term on your mortgage or other loans and/or to ease the stress of loan payments on your monthly budgets. Doing a little homework and comparison can help you evaluate whether refinancing is right for you.
For more information
StreetWise's Why and when should you refinance
DCU's Making Home Affordable information page
DCU Mortgage and Homebuying Calculators: Am I better off refinancing? and What will my refinancing costs be?
A Consumer's Guide to Mortgage Refinancings from the Federal Reserve Board
MakingHomeAffordable.gov

So, what do you think?
If you find this review helpful, please pass the word to your friends. Also email me with any comments or suggestions.
Remar Sutton

Prepared by Remar Sutton and Associates for DCU, May 2009. All rights reserved.

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Digital Federal Credit Union
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