Real Estate: Tapping your home equity by
refinancing
In the broadest sense, equity means ownership. Equity in a
home is the difference between the property's current market value (the amount
it could be sold for or appraised value) and any debt or claim against it. For
example, if you own a home currently valued at $300,000 but still owe $200,000
on your mortgage, your equity in the home is $100,000.
For example if you paid $100,000 for your home
and put down 5 %, you'd have $5,000 in equity. After 10 years of
mortgage payments, you'd probably have added another $10,000 in
equity by paying down your mortgage balance. However, during those
10 years, your home's value may have appreciated to $150,000. Now
you have $65,000 in equity in your home ($5,000 down payment,
$10,000 in mortgage balance paid and $50,000 in home
appreciation).
You can sell
your home to tap the equity or if you don't want to sell, there are 2 main ways
you can get your equity: One is to refinance and another is to get a
home equity loan or a
home equity line of credit.
What is
refinancing?
When you refinance, you are replacing an existing mortgage
with a new mortgage on the same property. There are many reasons why people
refinance their mortgage. Most people refinance to get a lower interest rate,
which reduces the monthly payment and often the overall cost of the mortgage.
Some refinance to get a shorter term mortgage (15 year mortgage) to replace a
longer term loan (30 year mortgage). While this may increase monthly payments,
it will save thousands in mortgage interest. Other people seek a fixed-rate
mortgage to replace their current adjustable-rate mortgage (ARM). They may do
this to get what they consider a better rate or to seek a rate that is
consistent over the term of the mortgage instead of changing during the term.
Another reason some people consider refinancing their mortgage is to consolidate
their debts. They may have a car loan, other installment loans, and credit card
loans--some of which may be at very high interest rates. Others want to get
money to use for home improvements or to help pay education costs. Some people
may want to refinance because of divorce. They want to remove the other person's
name from the mortgage papers.
Refinance doesn't come cheap. Since you are taking out a new
mortgage when you refinance, you often have to pay up-front fees and closing
costs again even if your mortgage is a few years old. Most of the costs are very
much like the costs you paid when getting your first mortgage. These costs
include an application fee, appraisal fee, and survey costs. They also include
homeowner's hazard insurance, lender's attorney review fees, and title search
and title insurance fees. Also involved may be home inspection fees, loan
origination fees, mortgage insurance, and points. That's especially true
if you switch lender for your new loan. Sometimes you can save some refinancing
costs by using the lender who holds your current mortgage. This is generally
true if your lender will waive particular costs, such as the survey because it
is still current.
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What is
loan to value ratio (LTV)?
Home equity lenders have
traditionally allowed you to borrow from your home equity until
you have reached a loan-to-value (LTV) ratio of 80%. The
loan-to-value ratio is the total money that you have borrowed on
your home divided by the value of your home.
If your home is worth a $100,000 and you have a $60,000 mortgage,
your LTV is 60%. If you then take out a home equity loan for
$20,000, your LTV rises to 80%. Lenders have typically allowed the
combined value of your first mortgage and your home equity loan to
be 80% of the home's value but lenders do allow higher LTV's -
some lenders will allow LTV's between 80% and 90% and some lenders
go as high as LTV's of 125%. There is of course a catch to this -
higher LTV loans cost more since they pose a greater degree of
risk to the lender. |
Should I refinance?
Years ago, the rule of thumb is that it pays to refinance if you can get an
interest rate at least 2 percent lower than you're currently paying on your
loan. In that way, your savings would pay off the costs within two years, and
you'd reap the benefits of lower rates. But the best way to figure out whether
you can save money by refinancing your current mortgage is to calculate your
savings using these 3 things: How much do you save in monthly payments, how much
will it cost to refinance and how long you plan to stay at your home.
Even a modest reduction in the loan rate can still trim
your monthly payment. For example, if you have a $100,000 loan at 8.5%, monthly
payment is about $770. If the rate were lowered to 7.5%, the monthly payment
would be about $700, a savings of $70. And if it cost you $3,500 in refinancing
costs, it will take 50 months ($3,500 divided by $70) to break even. So most
likely you should refinance this mortgage if you are planning to stay for more
than 50 months. If don't have the money to pay for associated loan costs, look
for lenders that offer 'no-cost' loans. These loans will charge a slightly
higher interest rate but you may still save money every month.
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Do I need a
new title policy when I refinance my mortgage?
You will not be required to
obtain a new owner's title policy when you refinance your
mortgage, but you will be required to obtain a new "lender's
policy" of title insurance, naming the lender as the insured. A
mortgage lender requires this new policy of title insurance to
be sure you have not incurred any new liens or encumbrances on
the property since the original time of purchase.
You may qualify for a
discounted rate or "re-issue" rate on this new title insurance
policy if your previous policy was issued in the last 2-5
years. Ask your title company or escrow officer if you qualify.
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