There are three different reasons for refinancing your Real Estate loan: 1) to pull equity out of your home, 2) to change the type of financing or to take care of a balloon payment, or 3) to save money on interest.
Pulling out equity: There are several different options for pulling cash out of a home. The basic ones are: 1) a reverse mortgage (for owners over 62 years of age,) 2) take out a 2nd loan, or 3) refinance the current loan for a higher loan amount. The important thing to discuss with your lender is what are the costs, risk, advantages and disadvantages of each option.
Changing the type of financing: Obviously if you have a balloon coming due and don’t happen to have the entire amount owed just laying around, you will have to refinance. However, having an adjustable rate mortgage, or because you don’t like writing two checks for your 1st and 2nd does not necessarily mean you should refinance. Before you move ahead with a refinance make sure that your lender explains exactly how your current financing works and what advantages, risk, etc. you have. Then carefully evaluate the costs and benefits of refinancing.
Saving money on interest: This is the most common reason to refinance, and if you can save money it’s a good idea. But what does it mean to save money? Is a lower payment always the best payment? What about the closing costs? This is where it gets confusing.
Let’s start with the closing costs – and yes, there are ALWAYS closing costs: There are two types of closing costs on any loan. The first type is those costs that you have to pay for the new loan. These are loan costs, appraisal costs, title costs, escrow costs, etc. Some of these fees are the same regardless of how much the loan is for, and some will vary with the loan amount. This is why lower loan amounts appear to have higher fees. For instance, a $500 appraisal fee is 1% of a $50,000 loan, but only 0.1% of a $500,000 one. The other fees are not really fees, but rather paying things you would be paying regardless of whether you refinance or not: Specifically taxes, insurance, and interest.
There are two ways to pay these fees: The first way is to just pay them – either by writing a check or adding the costs to your loan amount. The other way is to have the lender pay them by taking an interest rate that is higher so that they can cover the costs when they sell the loan. So which is best? That is something you should discuss with your lender. The advantage of paying the fees upfront is you get a better rate that will save the most money in the long run; however it may take a while to recover the costs with the lower rate. Paying the higher rate with little or no fees will have the benefit of saving money right away, but you will have the higher rate for the entire loan. (Note that many lenders only want to show you this option because it gives them the opportunity to refinance you again if rates drop by even a little bit; a good deal for them, but not necessarily for you.)
It doesn’t matter why you want to refinance, if you decide to refinance make sure you understand all the fees and the fine print. Being able to say you have the lowest rate around the water cooler at work isn’t the best reason to refinance. Sometimes those folks who sound like they refinance every six months, really are refinancing every six months! That’s great for their lender but likely not so great for them. Remember those fees, these folks pay them every time. Be sure to ask “how long will it take until I break even?” The lender should tell you how many years it will take before you have paid off the fees and now are actually seeing the benefit of that lower payment. If you plan to move or retire, that number could change your mind about refinancing. Really – sometimes the grass is greener right where you are.