Questions About Mortgage Refinancing
November 4, 2002, Revised July 2, 2007
"What questions about refinancing are asked most frequently?"
The most common question by far is "should I refinance". Usually I can’t answer it because questioners don’t give me all the needed information. If borrowers are looking solely to reduce costs and not to raise cash, I refer them to calculator 3a if they have one mortgage, and to 3b if they have two.
3a Refinancing One Mortgage
3b Refinancing Two Mortgages
These calculators answer the question, "will refinancing reduce my total financing cost?" The calculators force potential questioners to collect the information that affects the decision. Once they have it, they only need to enter it into the calculator, as I would do, to get the answer -- so they don’t need me.
"With interest rates so low, why isn’t the refinance decision a slam dunk?"
Sometimes it is. If a borrower with a 7% loan is offered a 6% loan with no refinance costs, the decision of whether or not to refinance is a slam-dunk; the deal will clearly leave the borrower better off.
But that doesn’t necessarily mean there isn’t a better deal out there. Nor does it mean that the borrower couldn’t lower the new rate even more by paying the refinance costs. Neither of these issues is a slam-dunk.
"When is no-cost refinance the right way to go?"
When you are sure to have the mortgage for less than 3-4 years. You either plan to sell the house within that period, or you are convinced that interest rates will fall further and you will refinance again.
If you expect to have the mortgage more than 3-4 years, paying the refinance costs in exchange for a lower interest rate is the way to go. Read Does No-Cost Refinance Make Sense. You can find the exact break-even period for yourself using my calculators 11a or 11b.
11a Break-Even Period on FRMs
11b Break-Even Period on ARMs
"Do you shop your current lender first?"
No, last.
The advantage of refinancing with your current lender is that he can usually cut some settlement costs out of the deal, and in some cases, can lower the interest rate without refinancing. The disadvantage is that your current lender is not motivated to give you the best deal, or the best service, because you are already a client.
You need to change your lender’s mindset in that regard. The way to do that is to find a good deal elsewhere, then notify your lender that you are refinancing. Then you select the better deal. Just make sure you compare them on the same day. Read Refinance Mortgage With Current Lender?
"How does making extra payments affect the decision to refinance?"
Ignore extra payments made in the past, that’s water over the dam. Looking ahead, if you are torn between repaying your loan in full or refinancing, consider repayment first. Repayment is an investment on which the yield is the rate at which you could refinance. [If you can refinance your current loan at 6%, for example, you earn 6% by paying it off.] Compare this to the returns on your investment alternatives. If you repay in full, that’s it.
If you don’t repay in full, consider the benefit of refinancing. If you plan to make extra payments in the future, you factor these plans into your analysis. In using my refinance calculators, you do that by shortening the remaining term of your new mortgage. If you plan to refinance into a 15-year loan, for example, but extra payments would result in payoff in 10 years, you use 10 years as the term. Read Are Mortgage Refinance and Prepayment Alternatives? You can determine the payoff period from any extra payments using calculator 2a, Effect of Extra Payments.
"How is the refinance decision affected if I want to take cash out of the transaction?"
If the main objective is to take out cash, the issue is no longer whether refinancing will lower costs. The issue is whether the cost of raising cash using a cash-out refinance is higher or lower than raising cash using a second mortgage. [A cash-out refinance is one for an amount in excess of the loan balance plus settlement costs].
A cash-out refi with an interest rate below the existing rate is likely to be less costly than a second mortgage. If the cash-out refi rate is higher than the existing rate, the second mortgage is likely to be cheaper, even though the second mortgage rate may be well above the cash-out refi rate. The reason is that the second mortgage allows the borrower to retain the lower rate on the existing mortgage.
But don’t depend on generalizations. Calculator 3d gives a precise answer. If you use the cash to consolidate existing debt, use calculators 1b or 1c.
3d Cash-Out Refi Versus Second Mortgage
1b Debt Consolidation, One Mortgage
1c Debt Consolidation, Two Mortgages
"What questions about refinancing are asked most frequently?"
The most common question by far is "should I refinance". Usually I can’t answer it because questioners don’t give me all the needed information. If borrowers are looking solely to reduce costs and not to raise cash, I refer them to calculator 3a if they have one mortgage, and to 3b if they have two.
3a Refinancing One Mortgage
3b Refinancing Two Mortgages
These calculators answer the question, "will refinancing reduce my total financing cost?" The calculators force potential questioners to collect the information that affects the decision. Once they have it, they only need to enter it into the calculator, as I would do, to get the answer -- so they don’t need me.
"With interest rates so low, why isn’t the refinance decision a slam dunk?"
Sometimes it is. If a borrower with a 7% loan is offered a 6% loan with no refinance costs, the decision of whether or not to refinance is a slam-dunk; the deal will clearly leave the borrower better off.
But that doesn’t necessarily mean there isn’t a better deal out there. Nor does it mean that the borrower couldn’t lower the new rate even more by paying the refinance costs. Neither of these issues is a slam-dunk.
"When is no-cost refinance the right way to go?"
When you are sure to have the mortgage for less than 3-4 years. You either plan to sell the house within that period, or you are convinced that interest rates will fall further and you will refinance again.
If you expect to have the mortgage more than 3-4 years, paying the refinance costs in exchange for a lower interest rate is the way to go. Read Does No-Cost Refinance Make Sense. You can find the exact break-even period for yourself using my calculators 11a or 11b.
11a Break-Even Period on FRMs
11b Break-Even Period on ARMs
"Do you shop your current lender first?"
No, last.
The advantage of refinancing with your current lender is that he can usually cut some settlement costs out of the deal, and in some cases, can lower the interest rate without refinancing. The disadvantage is that your current lender is not motivated to give you the best deal, or the best service, because you are already a client.
You need to change your lender’s mindset in that regard. The way to do that is to find a good deal elsewhere, then notify your lender that you are refinancing. Then you select the better deal. Just make sure you compare them on the same day. Read Refinance Mortgage With Current Lender?
"How does making extra payments affect the decision to refinance?"
Ignore extra payments made in the past, that’s water over the dam. Looking ahead, if you are torn between repaying your loan in full or refinancing, consider repayment first. Repayment is an investment on which the yield is the rate at which you could refinance. [If you can refinance your current loan at 6%, for example, you earn 6% by paying it off.] Compare this to the returns on your investment alternatives. If you repay in full, that’s it.
If you don’t repay in full, consider the benefit of refinancing. If you plan to make extra payments in the future, you factor these plans into your analysis. In using my refinance calculators, you do that by shortening the remaining term of your new mortgage. If you plan to refinance into a 15-year loan, for example, but extra payments would result in payoff in 10 years, you use 10 years as the term. Read Are Mortgage Refinance and Prepayment Alternatives? You can determine the payoff period from any extra payments using calculator 2a, Effect of Extra Payments.
"How is the refinance decision affected if I want to take cash out of the transaction?"
If the main objective is to take out cash, the issue is no longer whether refinancing will lower costs. The issue is whether the cost of raising cash using a cash-out refinance is higher or lower than raising cash using a second mortgage. [A cash-out refinance is one for an amount in excess of the loan balance plus settlement costs].
A cash-out refi with an interest rate below the existing rate is likely to be less costly than a second mortgage. If the cash-out refi rate is higher than the existing rate, the second mortgage is likely to be cheaper, even though the second mortgage rate may be well above the cash-out refi rate. The reason is that the second mortgage allows the borrower to retain the lower rate on the existing mortgage.
But don’t depend on generalizations. Calculator 3d gives a precise answer. If you use the cash to consolidate existing debt, use calculators 1b or 1c.
3d Cash-Out Refi Versus Second Mortgage
1b Debt Consolidation, One Mortgage
1c Debt Consolidation, Two Mortgages