Refinancing Simplified
Refinancing your primary home may seem like it should be a simple matter - you're already in the home, after all, and no property will change hands - but in reality it's often quite complicated.
The first thing you need to know when refinancing is your current interest rate and what benefits you'll incur with your refinance. The interest rate on your loan can be fixed, variable, or a hybrid of the two. If it is fixed, you will have a rate of 6.5% (for example), meaning that is the rate you will always pay when you make your monthly payments.
An adjustable interest rate varies according to an index, usually a published interest rate. Instead of an interest rate, you have a margin, for example, 1.5%. To determine your interest, determine the current base interest rate and add your margin to it. If the interest rate is 5.25% and your margin is 1.5% then your interest rate for that month will be 6.75%.
There are also hybrid rates in which you have a flat rate for a period of years that turns into an adjustable rate after a designated period, often five years. Often, refinancing involves changing from one type of interest rate to a more advantageous one.
In every case, it is very important to understand the difference between your interest rate and your APR. The APR, or Annual Percentage Rate, is your interest rate with the closing costs mixed in to give you an idea of what you are really paying. Two mortgage companies can offer to refinance your home for the same rate, say 5.25%. One of these two companies makes all its money charging exorbitant closing costs, and that is how they make their money, whereas the other company may have lower closing costs. If this is true, then you can compare the APRs and see which is a better deal. If one company charges you $10,000 in closing costs then their APR may be as high as 8 or 9%. The purpose of the APR is to keep consumers aware of the deal they are getting.
The next vital piece of information is knowing the size of your monthly payment and how many payments you have remaining, and how your refi will influence these. If it's a 30-year loan you will have 360 monthly payments to make before the house is yours. Even if you have a fixed rate, if you pay into an escrow account the rate could vary. The escrow account pays your home insurance and local taxes, both are which are subject to change. After a year there is an annual accounting and if you have overpaid you should get some money back.
Now that you know how much each payment is for, when it is due, and when you will be out of debt, there are several other features to look at. Does your loan have a pre-payment penalty? In other words, if you win the lottery and are able to afford to purchase the home outright immediately, is there some kind of penalty you must pay to get rid of the lien, so that the mortgage company can still make money? Knowing this is also important if you plan to refinance an additional time. If you refinance and there is a pre-pay penalty, and the next year interest rates drop and you refinance again, you will have to pay the pre-payment penalty because the refinancing involves paying off completely the old mortgage.
Also important to note is what happens if you can't or don't make your payments. A mortgage is a lien on your house that gives the mortgage company an ownership interest in your home. If you violate the terms you can lose your home. This is the most important thing to remember when refinancing. Will you be able to make the payments and what is the company's policy regarding non-payment or late payment?
When the day for the closing comes, you must sign and initial a huge stack of papers, often without being able to look at them carefully. If you are refinancing your personal home (i.e. it's not an investment property) you are given a three day right to rescind the entire transaction. After you sign the papers you can look over them carefully and have a lawyer or friend look them over, and if you have any questions or problems now is the time to contact the mortgage company.
If you can keep track of the changes in your interest rate, monthly payment amount (including escrow), number of payments, pre-payment penalties, late fees and the consequences of non-payment, refinancing can be a smooth process that does not take up too much of your time.
Author David L. Tamarin is a licensed attorney who conducts residential refinance closings in the Commonwealth of Massachusetts and writes real estate articles as well as fiction (short stories).