Refinancing, Home Equity Loans and other Property based Loans

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Refinancing your Mortgage

Refinancing of mortgages has always been a substantial business as clients go after more competitive interest rates. However, more recently, refinancing has received a boost through the provision of equity lines, that provide funding for almost the total market value of your home. There are a number of reasons why you would want to consider refinancing. Some of the main ones are:

Reasons for considering to Refinance the Mortgage
Lowering your interest rate Lower rates usually mean lower monthly payments
Adjusting the length (increasing or decreasing the term) of your mortgage Shorter-term mortgages--for example, a 15-year mortgage instead of a 30-year mortgage--generally have lower interest rates. Alternatively, you may want a mortgage with a longer term to reduce the amount that you pay each month.
Changing from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage If you have an adjustable-rate mortgage, (ARM), your monthly payments will change as the interest rate changes with the market. With this kind of mortgage, your payments could increase or decrease.

You may find the risk that your mortgage payments could go up with the market rate unacceptable.
Getting an ARM with better terms You may choose to refinance to get another ARM with better terms, eg. how often there is an interest rate adjustment etc.
Getting cash out from the equity built up in your home Remember, when you take out equity, you own less of your home. It will take time to build your equity back up. If you need to sell your home, you will not put as much money in your pocket after the sale

Many financial advisers caution against cash-out refinancing to pay down unsecured debt (such as credit cards) or short-term secured debt (such as car loans). You have want to talk with a trusted financial adviser, who knows your personal financial situation, before you choose cash-out refinancing as a debt-consolidation plan.

This is just a very short summary of reasons for refinancing. Though, if you intend to go ahead, it is essential to make a detailed list of why you refinance and what the financial effect of each individual reason is for you. Remember, there are also tax implication which you have to consider!

The Tax Issue (interest rate deduction) If you use the mortgage interest deduction on your income taxes, the cash effect of a lower interest rate is far less on an after-tax basis. Though, this will depend on your marginal federal income tax rate.

You should also note, you can only fully use your interest rate deduction if your itemized deductions including the mortgage interest expense are greater than the standard deduction by at least the amount of the mortgage interest expense.

You may want to talk to an accountant about your tax situation and what effect refinancing might have on that! Though, if you use common sense, and have some arithmentic ability, you should be able to determine that yourself.


When you should not consider to Refinance

You had your mortgage for a long time. The more mature your mortage, the smaller the savings with a lower interest rate. Unless naturally, if you lenghten the term and cash out equity.
Your current mortgage has a prepayment penalty Prepayment penalties can be hefty and will further lower any gain from a lower interest rate. Our advice is "Never sign a mortgage agreement with a prepayment penalty!"
You plan to move from your home in the next few years. Refinancing only pays if you stay at the home you own for a considerable number of years. Because the refinancing costs alone, will be substantial and deny you any short term gain from lower interest rates!

The table below gives you an indication as to how many years you have to be into the mortgage when any interest rate savings is no longer a deciding factor.

Amortization of a $200,000 loan for 30 years at 5.9%

Source: 2008 Federal Reserve

The Costs of Refinancing

The dollar cost of refinancing can be considerable. In most cases the same costs as those you originally paid, when you took out your first mortgage, have to be paid again. You can find those closing costs here. As a general rule, you have to be in the house for a further ten to 15 years, before you make up for these costs.

Beware of financial institutions offering "no costs closings" on refinancing. Often they just hide the closing costs into a marginally higher interest rate. Therefore look closely at the contractual obligations you sign.

There are numerous refinancing calculators available which show you what the interest rate on the new refinancing loan will have to be to make a refinancing viable. The very best of these REFINANCING CALCULATORS is provided here.

Home Equity Lines of Credit

A home equity line of credit is a form of revolving credit in which your property is the collateral. Usually, home owners use this line of credit for major expenditure, such as home improvements, educational or health related expenses.

The maximum credit line is often calculated on the basis shown below. In addition, other factors such as your ability to repay determined by your income,

Method of Calculating your Maximum Home Equity Credit Line
Appraised $ Market Value of Property 100,000
Lender's Maximum Percentage of Loan based on appraised value (this varies from lender to lender) 75,000
Subtract outstanding Mortgage (50,000)
Maximum Home Equity Line 25,000

other debts and your credit score, will be factors for the maximum amount that your lender will commit to you.

A revolving credit home equity line is operated like any other bank account and will normally have special checks. Minimum monthly repayments on home equity lines are sometimes required as a percentage of the amount you have borrowed at the time (usually about 2.0-4.0 percent of the borrowed amount).

You should also be aware that some lenders will require you

  • to borrow a minimum amount often between $300.00 and 500.00 per check (this lowers the cost to the lender) or transfer to another account; and
  • a lender might limit the time (maturity) of your credit line to five or ten years. Though, they will often agree to an extension or refinancing after that.

Most lenders will not make any other restrictions on the loan and you can draw on your credit line up to the preset limit. Although, it has recently been known, that lenders will decrease the maximum amount of the credit line, if your credit score suddenly deteriorates!

The Interest Rate for a Home Equity Line

The interest rate (APR) is usually variable, reflecting market rates. The rate must be based on a publicly available index, such as the prime rate, U.S, Treasury Bill, LIBOR or similar. Like with mortgages the home equity credit agreement will state the rate of interest as the interest index used "plus X percentage points margin". You can find out more about the index rate here.

Lenders sometimes use low introductory rates (teaser rates) that are valid for 6 months. Read the home equity loan agreement carefully, so that you exactly know what the conditions of the loan are. Be also aware, that there maybe closing costs, for such items as an appraisal, documentation and maybe other items. Make sure that you know exactly what these closing costs are, before you sign an agreement.

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