When you refinance your mortgage, you usually pay off your original mortgage and sign a new loan. With a new loan, you again pay most of the same costs you paid to get your original mortgage. These can include settlement costs, discount points, and other fees. You also may be charged a penalty for paying off your original loan early, although some states prohibit this. The total expense for refinancing a mortgage depends on the interest rate, number of points, and other costs required to obtain a loan.
To obtain the lowest rate offered, most mortgage companies will charge several points, and the total cost can run between three and six percent of the total amount you borrow. So, for example, on a $100,000 mortgage, the company might charge you between $3,000 and $6,000. However, some companies may offer zero points at a higher interest rate, which may significantly reduce your initial costs, although your payments may be somewhat higher.
Another way to make a refinance work for you is to refinance for more than the balance remaining on your old mortgage -- in effect, tapping your home equity, or "cashing out," in mortgage speak. Thanks to favorable rates, you may be able to do so without boosting your monthly outlay. For example, at 8.5%, the payment on a $200,000, 30-year fixed rate mortgage is $1,538. But at 7.5%, that same payment lets you borrow nearly $20,000 more.
The best use for the extra cash is to pay off any higher rate loans you may have. Let's say that you are carrying a $15,000 car loan at 10% and making minimum payments on a $10,000 credit card balance at 17%. Your monthly payments on those debts would total $680. Then assume you refinanced your mortgage, taking out an additional $25,000 to pay off your car and credit card loans. Result: At 7.5%, your additional monthly mortgage payment would total only $175, so you would come out $505 ahead ($680-$175=$505).
Of course, all the extra cash needn't go for paying off debts. When the Menards swapped their ARM for a fixed rate last December, they also increased their mortgage load by $34,000, from $106,000 to $140,000. They used $3,000 of the proceeds to pay their refinancing costs and another $17,000 to pay off a 10% home equity loan, which had been costing them $250 a month. Then they spent the remaining $14,000 to build a garage for Roger's antique car collection -- and they did all this for just another $19 a month.
When rates fall steadily, refinancing may make sense even if you have done so once already. Bob and Michelle Barbo of Kirkland, WA refinanced twice within three months in 1998. In October, they trimmed the rate on their 30-year fixed mortgage by a full point -- from 9.13% to 8.13% -- for a monthly savings of $63. Plus, because home prices in their area had boosted their home equity, they were able to stop paying private mortgage insurance that cost them $120 a month.
To exploit continued decline in rates, the Barbos refinanced again in December. Their new 30-year fixed mortgage is at 7.375%, lopping another $55 off their monthly bill. Since the couple had chosen a no cost refinancing each time, their total out of pocket expenses came to just $400 in appraisal fees. So by the time you read this, they will already have recouped their up front costs. "Now we can use the savings to build up a cash emergency fund," says Bob.
If you are considering a second refinancing, don't overlook this potential tax write off: When you pay points to refinance, you must deduct the amount over the life of the loan, usually 30 years. But when you refinance a second time, all of the points that have not yet been deducted from the first refinancing can be written off in a lump sum. Say you refinanced to a 30-year mortgage in 1993 and paid $3,000 in points. By now, you would have written off roughly $500. If you refinance again this year, you could deduct the remaining $2,500 on your 1998 tax return. For a homeowner in the 28% tax bracket, that works out to a savings of $700 -- enough to offset some or all of your costs this time around.
What Factors Determine Your FICO Score ?
Your FICO score is the numeric representation of your financial responsibility, based on your credit history. Most lenders use FICO credit risk scores to obtain a fast, objective measure of your credit risk. By understanding the factors that can help or hurt your score, you'll have a better understanding of how lenders see you and how you can improve your credit standing in order to obtain that refinance cash on your home mortgage.
The five factors that determine your FICO score are:
(1) Payment History (approximately 35% of your score)
The factor that has the biggest impact on your score is whether you've paid past credit accounts on time. However, an overall good credit picture can outweigh a few late payments, and late payments will continue to have less impact over time.
(2) Amounts Owed (approximately 30%)
Having credit accounts and owing money doesn't mean you're a high-risk borrower. But owing a lot of money on numerous accounts can suggest that you are overextended and more likely to make some payments late or not at all. Part of the science of scoring is determining how much debt is too much for a given credit profile.
(3) Length of Credit History (approximately 15%)
In general, a longer credit history will increase your FICO score. Lenders want to see that you can responsibly manage your available credit over time. However, even people who have not been using credit very long may get high scores, depending on how the rest of their credit report looks.
(4) New Credit (approximately 10%)
People today tend to have more credit and to shop for credit more frequently. But opening several credit accounts in a short period of time can represent greater risk-especially for people with short credit histories. Requests for new credit can also represent greater risk. However, FICO scores are able to distinguish between a search for many new credit accounts and rate shopping. FICO scores generally do not associate shopping for the best rate on a loan with higher risk.
(5)Types of Credit in Use (approximately 10%)
Your FICO score will reflect your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. While a healthy mix will improve your score, it is not necessary to have one of each, and it is not a good idea to open credit accounts you don't intend to use. The credit mix usually won't be a key factor in determining your score, but it will be more important if your credit report doesn't have much other information on which to base a score.
Interpreting Your Score ...
When you or a lender receives your FICO score, up to four “score reasons” accompany the score. This helps to explain the top reasons why your score was not higher. These reasons are more useful than the score itself in helping you determine how you might improve your score over time, and whether your credit report might contain errors. However, if you already have a high score (for example, in the mid-700s or higher) some of the reasons may not be very helpful, as they may reference the factors that have the least impact on your score, such as: length of credit history, new credit and types of credit in use.
Here are the top 10 most frequently given score reasons. Note that the specific wording given by your lender may be different from the reasons shown in this list.
1)Serious delinquency.
2)Serious delinquency, and public record or collection filed.
3)Derogatory public record or collection filed.
4)Time since delinquency is too recent or unknown.
5)Level of delinquency on accounts.
6)Number of accounts with delinquency.
7)Amount owed on accounts.
8)Proportion of balances to credit limits on revolving accounts is too high.
9)Length of time accounts have been established.
10)Too many accounts with balances.
Ten Ways to Improve Your FICO Score
When you apply for credit, your credit score helps lenders decide how likely it is that they'll get paid back on time. The most widely used credit bureau scores are developed by Fair, Isaac and Company. These are known as FICO scores. With a higher score you'll be able to qualify for better interest rates, higher credit limits, and more types of credit than you would with a low score. (See Your Credit Risk Score for more information.) There are no tricks or quick fixes to getting a good credit score, but you can raise your score over time by demonstrating that you consistently manage your credit responsibly. Here are 10 tips that can help you raise your score:
1)Pay your bills on time.
2)Proving that you can pay your bills on time is the best thing you can do to improve your score. And it's never too late to start. Even if you've had serious delinquencies in the past, these will count less over time.
3)Keep credit card balances low.
4)High outstanding debt can pull down your score.
5)Check your credit report for accuracy.
There may be inaccurate information on your credit report that can be easily cleared up. Always contact the original creditor and all three credit bureaus whenever you clear up an error, so that the inaccurate information won't reappear later. Requesting a copy of your credit report won't affect your score if you order it directly from the credit reporting agency or an authorized organization.
6)Pay off debt rather than moving it around.
7)Consolidating your credit card debt on one card or spreading it over multiple cards will not improve your score in the long run. The most effective way to improve your score is by simply paying down the amount you owe.
Have credit cards - but manage them responsibly.
In general, having credit cards and installment loans that you pay on time will raise your score. Someone who has no credit cards tends to have a lower score than someone who has managed credit cards responsibly.
8)Don't open multiple accounts too quickly especially if you have a short credit history.
This can look risky because you are taking on a lot of possible debt. New accounts will also lower the average age of your existing accounts, something that your FICO score also considers.
9)Don't close an account to remove it from your record.
A closed account will still show up on your credit report, and may be considered by the score. In fact, closing accounts can sometimes hurt your score unless you also pay down your debt at the same time.
10)Shop for a loan within a focused period of time.
FICO scores distinguish between a search for a single loan and a search for many new credit lines, based in part on the length of time over which recent requests for credit occur.
Don't open new credit card accounts you don't need.
This approach could backfire and actually lower your score.
Contact your creditors or see a legitimate credit counselor if you're having financial difficulties.
This won't improve your score immediately, but the sooner you begin managing your credit well and making timely payments, the sooner your score will get better.
These tips won't create a dramatic overnight jump in your credit score. Developing a solid credit history takes time. A good first step is to order your FICO score through myFICO.com, brought to you in partnership with Rock. When you get your score, you'll also get an explanation, ways you can improve it, and a full credit report from Equifax-one of the three major US credit reporting agencies.
When you're making your decision, there are several things to keep in mind.
First, even a small rate cut can pay off quickly. That's because you can easily find mortgage companies willing to waive routine refinancing charges such as application, appraisal and legal fees (which can add up to $1,500 to $3,000). Of course, in exchange for low or no up front costs, you'll have to be willing to accept a rate that's somewhat higher than the prevailing rock bottom.
Second, if you are planning to stay in your home for at least three to five years, it may make sense to pay "points" (a point equals 1% of the loan amount) and closing costs to get the lowest available rate.
Third, you can avoid laying out cash and still get a low rate by adding the points and closing costs to your new mortgage. Does that mean shouldering a lot of extra debt? Not necessarily. If you've had your current mortgage for at least three years, you've probably reduced your balance by several thousand dollars. So you may be able to tack your closing costs onto your new loan and still end up with a mortgage that's smaller than your original one -- plus, of course, a lower rate and lower monthly payment.
With a lower interest rate on your home mortgage refinance loan, you will have less interest to deduct on your income tax return. That, of course, may increase your tax payments and decrease the total savings you might obtain from a new, lower-interest mortgage.
You should be aware of an Internal Revenue Service (IRS) ruling with respect to points paid solely for refinancing your home mortgage. IRS regulations require that interest (points) paid up front for refinancing must be deducted over the life of the loan, not in the year you refinance, unless the loan is for home improvements. This means that if you paid a certain number of points, you would have to spread the tax deduction for those points over the life of the loan. If, however, the loan or a portion of the loan is for home improvements, you may be able to deduct the points or a portion of the points. Check with the IRS regarding the current rulings on refinancing, particularly if you are using the new loan to make home improvements.
