Home Refinancing 101

Home refinancing is usually done when homeowners have a mortgage on their home and apply for another secured loan to pay off the first mortgage. In general, a homeowner who refinances his or her home will do so for one of three reasons:

to lower monthly payments
to pay off a mortgage quickly
to take money out of the property's equity for other expenses

Home refinancing may not be right for every homeowner. If you are thinking about refinancing your home, there are many questions to consider first, particularly when a volatile economic climate exists.

When Is the Right Time to Refinance My Home?

If you are a homeowner with a variable-rate mortgage, it may make sense to refinance your home for a fixed-rate mortgage in an existing economic climate where interest rates are climbing. In order for this to be a wise choice, you should expect interest rates to continue to climb. For homeowners with a fixed-rate mortgage, the opposite may be true when interest rates are falling. If this is the case, you may want to lock in a mortgage with a new, lower fixed rate, or else take your chances with a refinanced variable-rate mortgage, expecting that interest rates will continue to sink.

Should I Get a Fixed-Rate or Adjustable-Rate Refinance Loan?

Whether you choose a fixed-rate mortgage or an adjustable-rate mortgage (ARM) may depend on how long you plan to stay in your home. Adjustable-rate mortgages may be difficult to acquire during volatile real estate market conditions. Some financial pundits recommend a fixed-rate mortgage if you plan to be in your home for at least seven years. This can act as a hedge against the possibility of rising mortgage interest rates. If you plan on staying in your home for less than seven years, an ARM may be a more affordable loan with lower monthly payments. However, as with all investments, variable-rate borrowers should always keep track of interest rate conditions. Use amortization calculators (see "Additional Resources" below), which project over time the difference in monthly payments between a fixed-rate mortgage and an adjustable-rate mortgage. Most major banks and lenders provide online calculators on their Web sites.

How Do I Find a Reputable Lending Institution to Refinance My Home?

Despite legislation against so-called “predatory lending”, there are still telemarketer and direct mail scams aimed at homeowners. Before entering into a refinance agreement, contact an expert, such as a bank officer from your current mortgage lender, a real estate attorney, or an adviser from a real property division (see http://www.abanet.org/rppt/cmtes/rp/home.html for more details).

Is a Home Equity Line of Credit (HELOC) a Type of Refinance Loan?

Although HELOCs and refinance loans are both second mortgages secured by your home's value, they have significant differences:

A HELOC offers more flexibility, allowing the homeowner to borrow up to the line of credit, easily pay off balances, and then borrow again up to the line of credit during the loan's term.
A refinance loan is repaid in equal payments over the loan term, and may have a fixed interest rate.
HELOCs offer both variable and fixed rates.
In terms of debt collection, repaying a refinance lender takes legal priority over repaying a HELOC lender.
HELOCs do not have the hefty closing costs of refinance mortgages, and in many instances you will not have to pay anything if you do not borrow against the HELOC.

What Is the Minimum Amount of Equity Needed for Most Mortgage Refinances?

Most refinance loan programs from financial institutions, including the Bank of America, require an equity amount of at least 10% of a home's value.

When Refinancing a Home, Are There Any Penalties to Be Aware of?

A pre-payment penalty included in your existing mortgage may affect any long-term savings benefits of a refinance loan. Some pre-payment penalties may be as high as 2% of 80% of the existing loan amount.

What Are the Fees Involved with Refinancing My Home?

With some lenders, refinance loans may include closing costs and fees similar to those that you had paid on your existing mortgage. Other lender fees may include property appraisal, borrower credit report, loan processing and underwriting costs, application fees, wire transfer fees, and funding fees. Third party fees may also be included in a refinance loan's cost amount. These may include attorney's fees, recording fees, inspections, postage/courier services, surveying, flood certification, and various government taxes.

Will I Need Title Insurance on a Refinance Loan?

Because a refinance loan is a new loan, you will be required by your lender to purchase lender's title insurance. Unlike homeowner's title insurance, this protects the lender's investment in your home. Note that borrowers who use their existing lender for the refinance loan may be able to negotiate a discount on title insurance as well as other fees.

Should I Spend at Least Part of My Refinance Loan to Consolidate Consumer Debt?

Some real estate finance experts recommend folding your high interest credit card debt into a lower interest rate refinance home mortgage. Others warn homeowners against foreclosure risks, particularly those homeowners adding more debt onto a variable rate mortgage during a volatile economic climate.

Additional Resources: