 Personal Finance PowerPoint Presentation, refinancing. Get ready to get financially fit by practicing personal finance. Most of this information can be found at Investopedia. Is refinancing my mortgage a good idea? Which you can find online. Take a look at the references, resources, continue your research from there. This is by Caroline Banton, updated August 11th, 2021. Is refinancing my mortgage a good idea? So typically when we're in the home purchasing or owning process, we normally can't put all the cash upfront, therefore need some kind of financing, some type of loan. And then of course, as time passes, questions come up as to whether it would be a good idea to refinance the loan or mortgage. The decision to refinance your home depends on many factors, including the length of time you plan to live there, current interest rates, and how long it will take to recoup your closing costs. So clearly to refinance a loan, it will cost to go through the refinancing process. So you wanna measure that or take that into consideration when making the decision. So in some cases, refinancing is a wise decision. In others, it may not be worth it financially. So meaning obviously you have to weigh the pros and cons of the costs of refinancing and the benefits that may come from it. And some of those pros and cons are gonna be estimates into the future, things that we don't know whether it's gonna happen into the future. So we'll have to make our best guess as of here and now, but an educated guess. Because you already own the property, refinancing is likely would be easier than securing a loan as a first time buyer. So you might be saying, man, I don't wanna go through the pain. Buying the house was very difficult, but you already own the home. So that should cut down a lot on some of the pain of the process. Refinancing hopefully would be a little bit easier to go through. Also, if you have owned your property or house for a long time and built up significant equity, that will make refinancing easier. So equity, you will recall is the difference between the loan amount and the home value, the fair value, the current value, the value, that gap, that equity can increase a couple of different ways. One, you could pay down the loan. When you pay down the loan, the amount that goes to interest just goes away because that's kinda like rent on the purchasing power, but the amount that goes to principal lowers the loan balance. And therefore, if the home stayed static, didn't go up or down in terms of fair market value and you paid down the loan, the gap, the equity, the difference between the asset and the liability would increase. Also, it could increase if, of course, the value of the home went up just simply due to market conditions. In that instance, it'll probably make it easier to go through a refinancing process because the bank, you'll recall, wants you to be somewhat invested in the home. They want like a 20% down oftentimes in the home so they feel that you are significantly invested in the home and so that if there was a foreclosure kind of situation that they would have sufficient recourse on the foreclosure to pay off the loan. So however, if tapping the equity or consolidating your debt is your reason for a refi, keep in mind that doing so can increase the number of years that you will owe on your mortgage. So clearly, if you're refinancing in order to tap into some of that cash flow, you're saying, hey, there's an increase in my equity. I wanna get some of that money in the equity as opposed to you're doing the refinance simply because there's a decrease in the rates in which case you're trying to lock in possibly a lower rate. If you're trying to get more money out of the equity situation, then that could lead to owning more money for a longer period of time, right? That's you're gonna refinance. So not the smartest of financial moves often times. So reasons to refi. Now, obviously you might need to do that if you're consolidating your debt and you have your debt, say in credit cards or in other things where the interest rate is quite high and you're deciding if I'm gonna have debt, where do I wanna have my debt? I don't want it in a credit card or something like that if the interest rates are very high and they're fluctuating all the time, maybe then it would be better to do the refinance in that kind of situation as a type of consolidation of the debt. But you'd have to compare that decision to the closing costs. You also wanna take into consideration tax consequences for how you might use the money during the refinancing process and see if there would be tax implications for deductibility of it. So reasons to refinance. So the general reason to refinance most of the time are when interest rates are going down. You possibly have a locked in interest rate that's higher than the current market rate. And so you want to basically refinance. At this point in time, the rates look like they're kind of trending up at this point in time. So you might have possibly gonna see less refinancing when interest rates are on the upward trend. You would expect generally you'd see a lot more refinancing when the interest rates are on the downward trend in general. So when does it make sense to refinance? The typical, should I refinance my mortgage rule of thumb is that if you can reduce your current interest rate by 1% or more, it might make sense because of the money you'll save. So if you're looking at the current market and you're saying, if I have a 30 year fix and I'm locked in and everything, but the current rates are a whole percent lower than what I'm currently locked in at, then it might be worth it to refinance even considering the closing costs and so on due to the reduction in the interest. So refinancing to a lower interest rate also allows you to build equity in your home more quickly. Now, obviously also if you have other kind of loans that are more exotic type of loans, maybe you had to take out multiple loans or something like that or an adjustable rate loan or something like that, just simply fixing the rate might be a reason to refinance it if you have an adjustable rate or something like that as well. So if interest rates have dropped low enough, it might be possible to refinance to shorten the loan term, say for my 30 year to 15 year fixed rate mortgage. So one thing you could do is say, I've got this long timeframe that I'm paying off the loan, which is great because I needed that in order to lower the payments that I'm making. But if the interest rates drop significantly, maybe I can make the same payments, for example, but paid off in 15 years instead of 30 years, which would lower the amount of interest that I would have to pay because I'd be paying it over a much shorter timeframe. So without changing the monthly payment by much. Similarly, falling interest rates could be a reason to convert from a fixed to an adjustable rate mortgage and arm as periodic adjustments on an arm should mean lower rates and smaller monthly payments. So if the rates are on the decrease, then you might be able to switch to the adjustable rate, but you gotta be really careful with the adjustable rates because clearly they will adjust based on the market. And again, it looks like right now the rates are going back up. So you're really kind of dependent on what's gonna happen with the market with the adjustable rate because the risk is transferring from the financial institution, the bank to you. The fact that the risk is transferring to you, you have more of the risk of the fluctuation going up and down on you as opposed to the bank means that you can often get more favorable rates that way, but you're also have more risk that you gotta balance out against it. So in a rising mortgage rate environment, this strategy makes less financial sense. That's probably the environment we're at right now. So indeed the periodic arm adjustments that increase the interest rate on your mortgage may make converting to a fixed rate loan a wise choice. So if you're thinking that the rates are gonna continue to increase, then you probably would like to have a fixed rate at this point in time so that you're not subject to the increases. And a lot of people are thinking the interest rates are still gonna go up, inflation's going up. Some people are having faith that they say, well, the Fed is gonna step in and take the interest rates back down. It's gonna be transitory after all, after all, but that's what you're gonna have to kind of gauge in terms of the market. And remember that the market usually has these longer cycles for the housing markets oftentimes. So we get into these like big 10 year cycles or something and we start to think that that's just the way it's always gonna be. And like I say with the Fed, we often think that the Fed has become so smart that they figured out interest rates and the interest rates will never go up again because we understand economics to that degree. But then you go through a period of flux and something happens and you see a bubble and then the faith goes down really, really low. And then interest rates in the same can happen with inflation. So if you're in a mindset and you've been in a market in either high interest rates or low interest rates for a long period of time, that doesn't mean that that period of time won't change. It just means that the cycle, in my opinion, is just longer. It doesn't generally mean that we figured it out. There's never gonna be a cycle anymore. But that's just my opinion. Consider closing costs. There are closing costs involved in all these scenarios. Your outlay may need to cover charges for title insurance, attorney's fee and appraisal taxes and transfer fees among others. These financing costs, which can be between 3% and 6% of the loan's principal are almost as high as the cost of an initial mortgage and can take years to recoup. So clearly you gotta make sure that the benefits you're getting will cover the closing costs. You can do a pretty quick kind of calculation to get an idea of that, taking the closing costs divided by the benefits or the lower in the payments, the decrease in the payments, for example, might give you a quick idea. If you are trying to reduce your monthly payments, beware of, quote, no closing costs and, quote, refinancing from lenders. So the no closing costs is kind of a deceptive term. It might be something that you would consider doing, but clearly there's no such thing as eliminating the closing costs. You can do some other stuff to it. You can roll the closing costs into the loan balance, which would increase the loan balance or possibly roll it into the interest rate, adjusting the interest rate, but then you would be paying it over time. If you increased the loan balance, you'd be paying interest on it as well. So it might be necessary for a cash flow purposes, but it also has its downsides because you're gonna pay interest on it. Although there may be no closing costs, they think likely will recoup those fees by giving you a higher interest rate, which would defeat your goal. So consider how long you plan to stay in your home. So in deciding whether or not to refinance, you'll want to calculate what your monthly savings will be when your finance is complete. So meaning you'll say, okay, if I refinance, what's my monthly savings? What's gonna be with a new amount that I'm going to be paying at that point in time? Let's say, for example, that you have a 30-year mortgage loan for 200,000. When you first assumed the loan, your interest rate was fixed at 6.5%. Your monthly payment was 1,257. If interest rates fall to 5.5%, fixed. This could reduce your monthly payment to 1,130, a savings of $127 per month. So that's gonna be a saving of 127 per month that you're gonna get. And you gotta balance that out against the fact that you got the closing costs that happen. So your lender can calculate your total closing costs for the refinance should you decide to proceed. If your costs amount to approximately 2,300, you can divide that figure by your savings to determine your breakeven point. So in other words, if we thought that out, we'd be doing something like this. We'd say, dude, it's been, it's like the interest rates are like a whole point lower. If I refinanced, my payments would be from 1,257. I'm paying now minus 1,130. That's a $127 savings. But I have to put down up front to get this thing done, $2,300. So if I save 127 a month, 2,300 divided by 127, then it's gonna take me like 18 months in order to save. Which is like, if I divide that by 12 months in a year, that'd be like one point, take me like a year and a half, which is not bad right there actually. So it'll take you that time to kind of recoup the closing cost. So clearly it's gonna take some time. So the longer you stay in the property, the better it would be. If you're gonna move in like three months, then it probably might not be the best idea. So if you plan to, so you can divide that figure by your savings to determine your break-even point. In this case, the home for two years or longer, refinancing would make sense. One and a half years in the home is the calculation. So if you plan to stay in the home for two years or longer, refinancing would make sense. If you want to refinance it with less than a 1% reduction, say 0.5% of the picture changes. Using the same example, your monthly payments would be reduced to $1,194, a savings of only $63 per month, or 757 annually. So if we took the 2,300 divided by the 756, we get three. So you would have to stay in the home for three years in that case. If your closing costs were higher, say 4,000, that period would jump to nearly five and a half years. So consider private mortgage insurance, the PMI, during periods when home values decline, many homes are appraised for much less than they had been appraised in the past. So if there's a decrease in the market, that's gonna affect your ability to refinance because the lender wants the equity in the home as the backup or support for the loan. So if this is the case when you are considering refinancing the lower valuation of your home, may mean that you now lack sufficient equity to satisfy 20% down payment on the new mortgage. And they want that 20% down payment because that means you're locked into the home. That means that if you stop making your payments, they could sell the home and still be able to recoup in terms of the sales price. They don't want the loan being equal to the home because that's too risky to refinance. You will be required to provide a larger cash deposit than you had expected or you may need to carry a PMI which will ultimately increase your monthly payments because then you're gonna have to pay for the insurance which messes the whole thing up. That messes it all up. I had a plan and this stupid... So it could mean that even with a drop in interest rates your real savings might not amount too much. Conversely, a refinance that will remove your PMI would save you money and might be worth doing for that reason alone. In other words, if you had to get the insurance and now you're in a situation where equity has increased and you're saying now I wanna get rid of the insurance I don't need it anymore because I've got 20% value in the home then you might refinance just to get rid of the insurance payment which could be beneficial. If your house has 20% or more equity you will not need to pay PMI unless you have an FHA mortgage different rules for the FHA mortgage that's where the government's kind of interplaying in here loan or you considered a high risk borrower. So if you currently pay PMI have at least 20% equity and your current lender will not remove the PMI that's another reason that you could refinance you're like whatever if you're not gonna take it out you're gonna so you're gonna ask the lender and if they would remove it because you got the 20% and you would think they would because you got the 20% but if they don't then you're like whatever I'll just refinance and that could be another reason that why you might take that road.