10 THINGS TO KNOW BEFORE YOU REFINANCE YOUR MORTGAGE

Introduction
Buying your home was probably one of the most significant financial decisions of your life. Now you are thinking about refinancing and, as when you purchased, you will have to live with the financial consequences of your decision for many years to come.

It is therefore important that you understand exactly how the refinancing process works, what your options are and how you can determine what is the best option for you and your family.

1. Should I refinance?
There are several reasons that you may be considering refinancing your home:
To lower your interest rate thereby reducing your monthly payment each month. To shorten the term of the loan saving thousands of dollars in interest. To take cash out to pay off other higher interest debt. Other reasons such as buying a second home, remodeling, paying for college tuition etc. Obviously, the reason that you are refinancing will change the factors that you need to consider in making your decision. If you are trying to lower your monthly payment you need to determine what the new loan will cost you, what your monthly payment will be, how much you will be saving each month and how long will you have those savings. Many people forget to consider the last factor but clearly if the closing costs for the new loan are $4,000 and you’re saving $200 per month, there is no point refinancing unless you are going to stay in your home for at least 20 months. As a rule of thumb, your new interest rate should be at least 1.5% - 2% less than your original rate in order to consider refinancing. If you want to shorten the term of your mortgage it is not normally necessary to refinance. You may have taken out a 30 year mortgage when you bought your house but now find that you have the money and the desire to pay it off much sooner than that. In most cases you will not need to refinance unless you are also trying to reduce your interest rate. Simply pay an additional amount each month along with your regular monthly payment and this amount will be applied to the principal balance thereby reducing the amount you owe, the total amount of interest you will owe and therefore the amount of time it will take to pay off the loan entirely.
To calculate how much extra to pay if you want to pay off your loan on a specific date, use our free mortgage loan calculator such as figure out the monthly payment for the length of loan that you would like. If your mortgage balance is currently $148,000 and you would like to pay it off in 7 years, simply enter these numbers and the interest rate into the loan calculator and you will be able to determine what your monthly payment needs to be in order to achieve that goal. If you are looking to take cash out in order to pay off debt or to pay for a large-ticket item then the interest rate may not be the most significant factor to you. If you are planning to pay off high interest credit card debt it may be worth refinancing even if the mortgage rate is slightly higher and if you need the cash to pay for your daughter’s wedding then you may have to refinance no matter how high the interest rate! A good mortgage broker will discuss your options with you in light of your specific situation and your financial goals.

2. What is LTV?
LTV stands for “Loan To Value” and is a term that is often thrown around by mortgage professionals because it is one of the key factors in determining the maximum loan amount and the interest rate. The LTV is simply the ratio of the loan amount to the value of the property. For example, if a property is worth $300,000 and the loan amount is $240,000 then the LTV is 80%.
For any given mortgage program from any lender there is a maximum LTV. If the particular mortgage program you are looking at has an 80% maximum LTV and you want to borrow $250,000 against a $300,000 property, you will have to find a different program or a different lender. Note that, all other things being equal, the higher LTV you want the higher interest rate you will pay and the harder it may be to qualify for the loan.
For instance, you may find that at lender has a program offering 80% LTV that you can qualify for with a 620 credit score. The same lender may require a 720 credit score for a 100% LTV.

3. What factors determine the interest rate for a specific borrower?
Economic conditions determine whether interest rates are generally high or low for everybody but there are other factors which influence the interest rate for each individual.
The main factors are:
Loan program – fixed rate mortgages have higher rates than adjustable, 15 year rates are lower than 30 year rates Credit score - the better your credit score the lower rate you will get.
Conversely, the lower your score the higher the rate. If your score is low enough you may not be able to qualify for any mortgage.

LTV - As mentioned above, generally speaking, the higher your
LTV ratio, the higher your interest rate will be.
Documentation - The more documentation your can provide, the lower your interest rate will be. There are programs that allow you to verify only your assets but not your income or even provide no documentation at all. These programs are great for people that need them but generally speaking if you have good income and assets and can document that with tax returns, pay stubs and bank statements, you may get a lower interest rate in return for the hassle of photocopying a lot of paperwork.

Points - Many people are attracted to mortgage lenders that offer no points or even no points and no closing costs. Of course, there is no such thing as a free lunch and typically the lower your closing costs, the higher your interest rate will be. As a rule of thumb, if you are planning to keep a property for more than 4 or 5 years, you should pay at least
two points in order to reduce your interest rate. If you are planning to move in 2 – 4 years, you should probably not pay points. If you are planning to move in less than 2 years, you probably shouldn’t refinance at all! Ask your broker to provide you with quotes for a mortgage with and without points and discuss with you the best choice for you in your situation.
Property type - Interest rates are always lower for primary residences as opposed to second homes and investment properties.

4. How much will closing costs be?
Closing costs can vary wildly from a few hundred dollars to several thousand. Keep in mind that even a “no closing cost” loan may require considerable out-of-pocket expenses on your part. If you review your original HUD- 1 statement from when you bought the house (the HUD-1 details each and every penny of the mortgage transaction) you will see that there are “closing costs” and there are “pre-paid” items which together make up the total “settlement charges.” While there are programs that offer no closing costs there are none that offer “no settlement charges'' Pre-paid items include things such as pre-paid interest (for the period of time between the closing date and the end of that calendar month), pre-paid real estate taxes and insurance (up to 6 months worth in some cases) and PMI. Even if you are rolling all these expenses into the loan amount, the settlement charges can come as a shock at the closing table especially in some states such as New York which have very high school/property taxes as well as a refinance tax. The other main components of your closing costs are origination points (discussed above), and title insurance both of which are based on the loan amount. At least with origination points you can be comfortable that you are getting something for your money (a lower interest rate). Title insurance offers no benefits to you but can be extremely expensive depending on the size of the loan. Title insurance protects the lender from losses due to a defective title but it is the borrower that has to pay for this insurance policy. Even though title has been checked and re-checked and even though you paid for title insurance when you first took out a mortgage, you have to pay for it again when you refinance, indeed every time you refinance! Note that title insurance does not protect the home-owner/borrower. It is possible to buy owner’s coverage as well (at a discounted price) but most borrowers do not choose to do so. The rest of the closing costs are relatively small by themselves although they can add up to a significant amount: processing and underwriting fees may be around $500, attorney fees another $500 or so and then there are all the little bits and pieces; recording fees, courier fees, flood certificates, title search etc. etc. Keep in mind that the attorney fees mentioned here that will be paid for at closing are for the bank attorney even though you are paying the fee. You are of course welcome to have your own attorney at the closing although there will of course be another fee that you will have to pay to your own attorney. The good news is that in most cases when refinancing, the closing costs and pre-paid items can be rolled into the loan amount so that you don’t have to come up with any cash at closing. Adding a few thousand dollars to your mortgage balance may increase your payment $10, $20 or $30 per month but if the lower interest rate is saving you $200 per month, then the closing costs have to be looked at in perspective.

5. Fixed or adjustable rate mortgage?
Having decided to refinance, one of the most significant decisions you will have to make is whether to get a fixed rate mortgage or an adjustable. Although for economists this is a very complex question, for the average borrower it boils down to consideration of two fairly simple questions, one factual and one emotional. The factual question is, how long do you plan to keep this property? If you know that you are going to be selling the property within 3 to 5 years then clearly you should get an adjustable rate mortgage. The most common adjustable rate mortgages have fixed interest rates for either the first 3 years of the first 5 years. Both 3 year and 5 year ARMS will offer better rates than a 30 – year fixed. Why pay a higher interest rate to lock that rate in for 30 years when you know that you will actually only have this mortgage for 3 years? (The same is true if you know that you are planning to refinance again in 5 years in order, for example, to buy a vacation property).
If you do not plan to move or refinance within 5 – 7 years, then your decision becomes purely an emotional one. (We will ignore the tiny, probably non-existent, percentage of the population that can accurately predict interest rate movements for the next 7 years). The question becomes, do you like to take risks? If so, chose an adjustable rate mortgage knowing that you will have a lower interest rate for some period of time and, if rates stay flat or go down, you will save even more money. Of course, the risk is that rates will rise and at the end of your 3 or 5 year fixed interest period, you may find your monthly payment going up and up each year.
If you are the more conservative type, then you should chose the 30-year fixed. Sure, to start with you’ll be paying more each month than your risk-taking neighbor but you’ll never have to worry about the vagaries of the economy and what impact they will have on your monthly mortgage payment. (Keep in mind that the average 30-year fixed mortgage only lasts 4.9 years. This means that the majority of Americans are paying a much higher rate than they have to but actually getting no benefit from it.
For a different type of mortgage program that combines the low payment of an adjustable with the peace of mind of a fixed rate, see question 10 at the end of this refinance guide.

6. Will I have to pay a penalty if I re-finance and pay off my current mortgage early?
There are two questions to consider; firstly, does your current mortgage have a pre- payment penalty? Many mortgage programs do contain a pre-payment penalty and it is not uncommon for a borrower to be unaware of whether their mortgage does have such a clause. In all the excitement of buying a house, qualifying for a loan, etc. etc., one of the last questions on anybody’s mind is ‘what happens if I pay this off early?’ If you have been in your house for more than three years (and you haven’t refinanced in the last three years) then it is unlikely that you will have to pay a pre-payment penalty. Most pre-payment penalties last for three years or less. If your current mortgage is less than 3 years old then you will have to check the small print, or check with your lender, to see if there is a penalty and, if so, how big a penalty it is. In some cases, it can be fairly significant – maybe 3% of the loan amount – and would be a major factor in your decision whether or not to refinance.
If you have determined that you will not have to pay a penalty, or that the penalty is small enough that it still makes sense to refinance, then you will have to decide whether to accept a pre-payment penalty on your new mortgage. As with points, at first glance this may seem like a bad thing but in many cases it may make sense for you to accept a mortgage with a penalty. If you know that you are not going to move or refinance again in the next three years, then tell your mortgage broker that you’re quite happy with a pre- payment penalty – as you will never have to pay the penalty (because you’re not moving) there is no downside but you may be able to qualify for a mortgage program with a lower interest rate than if you insisted on a mortgage without the penalty clause.
Be aware that there are two types of pre-payment penalty; hard and soft. A hard pre- payment penalty kicks in whether you sell your house or simply refinance. A soft penalty only applies if you refinance, not if you sell. If you think that you might move in the next three years but know that you will not refinance again in three years, tell your broker that you will accept a mortgage with a SOFT pre-payment penalty.

7. Will I have to show proof of income? Assets? Employment?
As mentioned before, there are different programs which will require different levels of documentation. Generally speaking, the more documentation you provide the lower your interest rate will be. You will also find that other program parameters are more lenient if you provide full documentation. For instance, the credit requirements will be lower and the maximum LTV may be higher.

There are three basic types of documentation that may be required. Each lender has slight variations on these themes but this will give you an idea of the documentation that will be required:
Full documentation
(Verify income and assets)
Two recent pay stubs
Two years tax returns and W2s
Two months bank statements
Most recent quarterly statement for investment accounts
CPA letter if self-employed
ID – (driver’s license etc.)
Stated
(Verify assets. State income but must be ‘reasonable’ for line of work)
Income
Two months bank statements
Most recent quarterly statement for investment accounts
ID

No documentation
(No asset or income verification required)
ID
In most cases, regardless of the type of documentation required, employment verification will be required. Most lenders prefer to see some degree of employment stability – ideally, the borrower should have been in the same job, or at least the same line of work, for at least two years without any gaps in employment.

8. Will I have to pay PMI?
Typically PMI, Private Mortgage Insurance, is required if your LTV is greater than 80%.
However, if you do need to borrow more than 80% there may be another option that makes more sense financially. Instead of taking out one mortgage for, say, 90% of the property value, you can take out a first mortgage for 80% and a second mortgage for 10% of the value. Although the second mortgage will be at a higher interest rate (because second mortgages are riskier for the lender) the higher rate will only apply to a relatively small loan amount so it is likely that the combined payment will be less than the payment of a 90% loan plus the monthly premium for PMI.
If you are borrowing more than 80% of your property’s value, your mortgage broker should be able to advise you which option is better for you in your situation.

9. Can I refinance an investment property or second home?
Yes. Investment properties and second homes can be refinanced like a primary residence either to reduce the payment, the loan term or to take cash out. However, lenders consider these types of property more risky than a primary residence so loan parameters will be more restrictive. For instance, the maximum LTV will be lower, the credit score requirement may be higher, the interest rate will be higher etc. etc.
Having said that, may people routinely refinance their investment properties as a way of turning the equity in the property into cash. Every few years, as the property continues to appreciate, they refinance taking out as much cash as they can. This cash can then be invested, used to buy additional properties or simply used as income thereby giving the property owner a constant cash flow without having to buy and sell properties.

10. How can I reduce my mortgage payment as much as possible?
The most common reason for refinancing is to reduce the monthly payment. If you are looking to reduce your payment to the absolute minimum then you may want to consider a slightly different type of mortgage that reduces your payment more than any other mortgage program while still giving you some of the payment certainty of a fixed rate mortgage. We call this The Monthly Advantage Mortgage.
The low start rate of this mortgage means that the payment on a $200,000 mortgage would be $643.28. Compare this to a typical mortgage at 6% where the payment would be almost $1,200 and you can see that regardless of what type of mortgage you have, the Monthly Advantage Mortgage offers considerable savings.
It is important to note that the monthly payment can increase after the first year and may increase every year between years 2 and 5. However, even with the maximum allowed increase each year, the payments in year 5 would still only be $859.08 – still $340 less than the payment on a 6% mortgage.