Which Refinance Is Best?
Today’s refinancing households have a multitude of mortgage programs from which to choose. Each program carries its own mortgage rates and rules, so you’ll want to make sure to pick the optimal program for you and your home.
The conventional home refinance is best for homeowners who have a significant amount of home equity, and good credit scores. Conventional loans are backed by either Fannie Mae or Freddie Mac and are available in several formats. The first format is the Rate-and-Term Refinance. In a Rate-and-Term Refinance, you are changing either the rate of your loan, the term (i.e. length) of your loan, or both. Refinancing costs can be rolled into the existing balance of the current loan, so that there is no cash out of pocket at the closing. This technique will increase the principal balance of the new loan. This is a good strategy as long as the homeowner has sufficient equity in the home to account for the increased loan balance as a result of rolling in the closing costs into a new loan balance. As an alternative, the homeowner can bring cash to the table at closing to account for refinancing costs, avoiding increasing the loan balance. In this situation it’s always a good idea to calculate the payoff of the closing costs paid in cash by calculating the annual savings of the lower monthly payment. As a general rule, if closing costs are paid in cash at the closing, the payback to account for the cash to refinance, should come from the lower payment and should be 24 months of less. Your loan size remains mostly unchanged. An example of a Rate-and-Term Refinance is a homeowner reducing his 30-year mortgage rate from 4.5 percent to 3.5 percent; or changing from a 30-year fixed mortgage to a 15-year fixed loan, or changing his term anywhere from 8 years to 30 years. This strategy will usually increase the amount of the monthly payments due to smaller loan term. This means the monthly payment is attributed to reduction of the principal loan balance, rather than paying interest. This strategy will reduce the total interest cost paid over the term of the loan by tens of thousands of dollars. A great strategy if the homeowner plans to remain in the current home with the new loan terms for the remainder of the payoff period of the loan.
The second refinance format is a Cash-Out Refinance. In a Cash-Out Refinance, the homeowners increases its loan balance and typically receives the additional borrowed amount as cash paid at closing. Sometimes, a Cash-Out Refinance is used for debt consolidation and the additional borrowed amount is dispersed directly to a bank or other creditor. The conventional mortgage refinance is one of the few programs to allow for Cash Out, so homeowners wanting to extract home equity should look at conventional financing first; as should homeowners refinancing a second home or investment property. Lastly, the conventional refinance could be a terrific way for FHA homeowners to Cancel their FHA MIP. Rather than refinancing with another FHA loan product, homeowners refinance to a conventional loan instead and payoff the existing FHA mortgage loan. This strategy is increasingly popular as home values recover nationwide and homeowners with existing FHA mortgages refinance and remove the monthly payment that pays the FHA monthly mortgage premium, savings hundreds of dollars a year.