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Using Your Home Equity

4 steps to evaluating your current loan
(Tue, 26 Feb 2008 10:30:00 EST)

Thinking of refinancing? Here's how to evaluate your loan before you make a move.

The prospect of a lower interest rate may have you thinking about refinancing. Or you may be looking to refinance to replace an adjustable-rate mortgage. Whatever your reason, refinancing your loan has the potential to save you money. But how do you know whether you can really save by refinancing your current loan, and whether the savings are worth the cost?

Here's a step-by-step guide to evaluating your current loan:

Step 1: Pull out your loan documents and look at the terms.
What interest rate are you paying? Is the rate fixed or adjustable? If you have an ARM, when is your rate due to reset? To figure out how much your rate (and monthly payments) could increase, look for your loan's index and margin as noted on your loan documents. Read more about how ARM interest rates are calculated in our article ARM indexes. And finally, is there a prepayment penalty that could cost you big money if you refinance?

Step 2: Compare your loan's interest rate with current interest rates.
If you took out a fixed-rate mortgage several years ago and interest rates have since dropped, refinancing may lower your payments considerably. A $150,000 mortgage with a 30-year term and a rate of 8 percent, for example, carries a monthly payment of $1,100. The same mortgage at 6 percent will have a payment of less than $900 a month. Remember, the interest rate you qualify for is based on several factors, including your credit score and your loan-to-value ratio. So don't automatically assume that you'll qualify for the lowest rate out there.

Step 3: Think about how long you expect to stay in your home.
Before you make a move to refinance, it's a good idea to think realistically about your long-term plans. If you expect to move in a year or two, you may not realize the savings you could potentially get from refinancing. In general, the longer you plan to stay in your home, the more sense it may make to refinance.

Step 4: Figure out your break-even point on the refinance.
If your closing costs will be $3,500 and you'll save $100 a month on payments, it will take you almost three years to recoup those costs. If you plan to move in a year or two, refinancing may cost you more than it saves you. If you plan to stay longer, though, the savings through lower monthly payments can really add up. For more information on calculating your break-even point read the article When does mortgage refinancing pay  or use the LendingTree.com Mortgage Refinancing calculator.

Other factors can come into play when you evaluate your current loan and compare it with refinancing options. For example, you can save on interest over the life of the loan by refinancing into a 15-year fixed loan rather than a 30-year loan. Your monthly payments will be higher than on a 30-year term, but you'll pay less interest over all by choosing a shorter term.

You can easily evaluate your current loan and compare it with possible refinancing options using the no-obligation LendingTree Mortgage Checkup.

Should you refinance your ARM before it resets?
(Mon, 17 Sep 2007 16:30:00 EST)

You may be better off refinancing your adjustable rate mortgage (ARM) and paying a little more now in order to save a lot more down the line.

Most people choose adjustable-rate mortgages (ARMs) over fixed-rate loans because of their lower initial monthly payments. However, the rate and monthly payment of an ARM is eventually adjusted, or reset. For example, a 5/1 ARM resets after five years, and then annually after that. During periods of falling interest rates, the adjustments can be welcome. When rates are rising, however, you'll have to brace yourself for higher monthly payments.

In order to help you determine whether you may benefit from refinancing, consider the following:

The rate caps on your mortgage
If you have an ARM that is about to reset, it's crucial that you understand the caps on your loan. Caps are limits on the amount your interest rate (and, subsequently, your monthly payment) can go up. They are designed to protect you from the shock of extreme rate increases. There are three main types:

• The initial cap limits the amount your rate can go up at the first adjustment period.
• The periodic cap sets the maximum increase for any single adjustment.
• The lifetime cap restricts the overall amount your interest rate can be raised over the entire mortgage term.

As an example, imagine that you have a 3/1 ARM with an initial rate of 4 percent. Your initial and periodic caps are both 2 percent, and the lifetime cap is 6 percent. Now let's assume your mortgage will reset for the first time in one month, and interest rates have risen since you obtained your loan. If your new fully indexed rate were 6.5 percent, your initial cap would protect you, keeping your actual rate at just 6 percent.

Note, however, that your loan will be adjusted again a year from now, and even if interest rates stay the same, your ARM will go up to 6.5 percent, because an increase of 0.5 percent is still well under the periodic cap of 2 percent. As long as interest rates continue climbing, your mortgage rate will climb with it, by a maximum of 2 percent a year, until the lifetime cap halts the increase at 10 percent. That's why caps may not provide long-term protection against rate increases.

Current interest rate trends
When rates appear to be rising over a long horizon, it may make sense to refinance your ARM before it resets, especially if you're planning to stay in your home for several years. By locking in now for three, five or seven-or-more years, you can protect yourself from the possibility of steadily climbing rates.

Here's an example. Assume you have an ARM with a principal of $200,000 and 25 years left on its term. Your current rate is just 4 percent, but it will reset in one year, and you expect the new rate will be 5.5 percent, rising to 6.5 percent the year after, and an additional 0.5 percent at each of the next two annual adjustments. Here's how your monthly payments would look:

	Current	In 1 year	In 2 years	In 3 years	In 4 years
Interest  rate	4%	5.5%	6.5%	7%	7.5%
Monthly payment	$1,056	$1,222	$1,337	$1,394	$1,450

Now imagine refinancing your mortgage today, a full year before your current one resets. You opt for a 5/1 ARM with an initial rate of 5.75 percent, which will remain fixed for five years. This rate is much higher than your current one, and even more than the new rate you expect in one year. Your new monthly payment would be $1,258, considerably higher than the payments you'll be making over the next 24 months. However, by the time you get to year three, your choice would be looking pretty good. And in four years, your monthly payment will be almost $200 less than it would have been with your old ARM. Over the first five years of your new mortgage, you will pay about $2,000 less interest.

The cost of refinancing
Of course, even though interest rates have been trending upward since 2005, no one can predict for certain where interest rates will be headed next month, let alone four years from now. If they rise more sharply than in our example, refinancing could save you even more. On the other hand, if rates decline, refinancing may look unwise in hindsight. Remember, too, that refinancing carries upfront costs that eat into your overall savings. In general, the longer you are planning to stay in your home, the more sense it makes to refinance now.

To help you determine what your new monthly payments are likely to be when your ARM resets, use the LendingTree adjustable rate mortgage payment calculator.

 

How to avoid ARM reset shock
(Mon, 27 Aug 2007 13:51:26 EST)

Concerned about rising interest rates? There are a number of ways to protect yourself from rate shock when your adjustable rate mortgage resets.

Adjustable rate mortgages (ARMs) have their advantages. For one, they often have an initial interest rate that is lower than a fixed rate mortgage. But they also have a disadvantage: one day, their interest rate will change, and you may find yourself facing "ARM reset shock."

This occurs when the initial period is up and the interest rate is adjusted, or reset, to the current rate. Your payment then changes accordingly. If interest rates have gone up during that time -- or if the initial rate was an artificially low "teaser" rate -- your payment may go up steeply.

This rate shock can be even greater if you have a hybrid ARM. These mortgages have a low initial rate that stays fixed for a set period -- usually two to five years. During that time, it's easy to forget about the possibility of future higher payments should interest rates rise. But they may rise significantly at the end of the fixed-rate period. And possibly continue to rise at every subsequent six- or 12-month adjustment period.

The impact can be even more pronounced in the case of an ARM that has a discounted initial rate -- a rate that's lower than it's fully indexed rate. For example, let's assume you take out a $200,000 mortgage with a 30-year term, an initial one-year discounted rate of 4 percent and a fully indexed rate of 6 percent. According to the Federal Reserve Board's Consumer Handbook on Adjustable Rate Mortgages, your first year monthly payments would be $954.83. But in the second year, when the discount period ends and the rate jumps to the fully indexed 6 percent, your payments would rise to $1,192.63. And if the index rate had also risen 1 percent during that period increasing the rate to 7 percent, your monthly payments would increase to $1,320.59. That's an increase of $365.76 a month!

You could have a different kind of reset problem if you've been making the lowest allowable payment on an option ARM. These payments typically don't cover all of the interest due on the loan, so your mortgage principal may actually be increasing. When the option ARM is recalculated, or recast -- usually after five years -- the higher balance is calculated in. Your payments can increase sharply, especially if interest rates have also risen. And the rate cap will not apply to this calculation.

If you have an ARM, it's important to know when your reset date will arrive. But what can you do to protect yourself from rate shock when it does? Here are a few suggestions:

• Refinance to a fixed-rate mortgage before the reset date arrives. If you're concerned about rising interest rates, consider refinancing. While your monthly payments may increase, you will be protected from future increases. But be sure to check if your mortgage has any prepayment penalties and to consider all of the other costs involved to determine if refinancing is right for you. Also, refinancing usually only makes sense if you plan to be in your home for several more years.

• Start a savings account so you can pay off a substantial portion of your mortgage when the reset date arrives. Check whether the terms of your mortgage allow you to do this without a prepayment penalty.

• Pay more than the minimum amount if you have an option ARM. If you've been paying only the least amount required, start paying the fully amortized amount. This will begin to reduce your mortgage balance before the recalculation date. If that's not feasible, switch to the interest-only option so at least your mortgage balance won't increase any more.

• Consolidate your debt. If a higher mortgage payment is going to make it hard for you to get by, consider seeing a credit counselor. There may be ways to restructure some of your high-interest debt by consolidating it into one lower-interest loan so you can afford the higher payments on your mortgage.

• Cut other expenses. Look to where you can cut costs to save more money. Some good places to start are services such as cable, DVR, cell phone, satellite radio, broadband internet, etc.

• Rent out part of your home. If your home is large enough, and your zoning regulations allow it, consider taking in tenants to help generate some extra cash to make the new payments.

• Downsize. If none of the above options can solve your problem, you may have to consider selling your home and downsizing to a home you can more easily afford. It's better than facing the threat of defaulting on your mortgage. And you can always move up again in a few years once you've built up your home equity.

For more help understanding your options if you have an adjustable rate mortgage, visit LendingTree ARM Central.

Is it time to refinance your ARM?
(Sat, 25 Aug 2007 10:30:00 EST)

If you have an adjustable rate mortgage, you may benefit from refinancing. Here's what to consider.

There are many ways you can benefit in both the short and long term from refinancing an adjustable rate mortgage (ARM). You may be able to get:

• A lower margin. If your credit score has improved since you took out your mortgage, you may be able to refinance to an ARM with a lower margin and save. This is because the size of the margin (the amount that's added onto a specific index to calculate the interest rate you're charged) is partly based on the credit score you have at the time you apply for a mortgage. A better credit score can mean a lower margin and lower interest payments.
• More stable payments. One of the downsides of an ARM is that there is always the potential risk of a rise in your monthly payments. In a rising rate environment, you may want to consider refinancing to a fixed-rate mortgage to protect yourself from future rate increases. Alternatively, it may be possible to protect yourself by refinancing to another ARM with more favorable caps -- limits on how much your payments can rise.
• Faster ownership of your home. Refinancing to a shorter term, say from a 30-year term to a 15-year term, will allow you to pay off your mortgage much faster and save you thousands of dollars in interest payments.
• Access to your home equity. If you have a good portion of your home already paid off, you might consider refinancing to a new mortgage with a higher principal. You'll receive the extra amount in cash, which you can use to consolidate debt or make a major purchase.

So how do you know when it's the right time to refinance your ARM? Consider the following factors:

• The new rate. As a rule of thumb, it's worth considering a refinance if your new interest rate will be around 1.5 to 2 percent lower than your current rate. (Otherwise, fees may eat up any potential savings.) Compare your current rate with the posted rates offered by other lenders, but be sure to ask about the index and margin -- if they are different from those of your existing ARM, you may be comparing apples and oranges. The loan's annual percentage rate (APR) can be a helpful yardstick. Unlike the interest rate alone, it includes other charges or fees to reflect the total cost of the loan.
• Closing costs. When you refinance -- just like when you took out your original mortgage -- you'll face fees that can add up and cancel out some of what you'll save by obtaining a lower rate. Use the LendingTree refinance calculator to help you determine how long it will take for you to break even on the charges.
• Interest rate trends. ARMs offer an advantage at times of falling interest rates. But if you fear interest rates may rise, you might want to consider refinancing your ARM for a mortgage with a fixed rate and consistent monthly payments. A fixed-rate mortgage will carry a higher rate initially, but locking in when rates are low can save you in the long term.
• How long you'll stay in your home. If you plan to move in a year or two, refinancing will generally not pay for itself. Let's assume that your new mortgage will save you $150 a month and that the cost of acquiring it is $4,500. Your break-even point is 30 months ($4,500 ÷ $150), so you'll want to stay in your home at least that long to make refinancing pay off.

Mortgage refinancing basics
(Fri, 13 Jul 2007 10:30:53 EST)

Weigh the costs and benefits of mortgage refinancing to determine if you'll come out ahead.

Your mortgage may have a 30-year term, but not many homeowners stay with the same loan for that long. In fact, the average American refinances his or her mortgage every four years, according to the Mortgage Bankers Association. That's because paying off your present mortgage and taking out a new one can mean big savings over several years. However, mortgage refinancing comes with a price in the short term, so it's important to consider both the costs and benefits before making your decision.

Why refinance?
Here are some reasons to consider mortgage refinancing:

• To obtain a lower fixed rate. If you took out a fixed-rate mortgage several years ago and interest rates have since dropped, refinancing may lower your payments considerably. A $150,000 mortgage with a 30-year term and a rate of 8 percent, for example, carries a monthly payment of $1,100. The same mortgage at 6 percent will have a payment of less than $900 a month.
• To switch to a fixed rate or an adjustable rate mortgage. Adjustable-rate mortgages (ARMs) offer lower interest rates initially, but some homeowners find the fluctuations stressful. If rates are on the way up, you might consider locking in at a fixed rate and consistent monthly payment. On the other hand, if you want to reduce your monthly payments and are comfortable with the interest rate changes of an ARM, it could save you money to refinance to an ARM.
• To improve the features of your ARM. Mortgages with adjustable rates have protective caps that limit how much your payments can increase in any given year and over the full term of the loan. You may be dissatisfied with the caps on your current ARM and feel you can negotiate more favorable features if you refinance.
• To build your home equity faster. If a recent change in your financial situation has made it possible for you increase your monthly payments, you might want to refinance your mortgage with a shorter term. The higher payments will enable you to pay off your home more quickly and to save substantially on long-term interest charges. However, if you are disciplined you can also opt not to refinance and simply pay more towards your principal each month.
• To reduce your monthly payments. Refinancing for a longer term will lower the amount you have to pay each month. You will end up paying more in interest charges over the life of your loan, but if you're having difficulty making your current payments, this strategy could provide some relief.
• To turn home equity into cash. You may want to take out a new mortgage with a larger principal, in order to turn some of your home equity into cash for a major expense. This is called cash-out refinancing. The advantage of taking out a loan secured by your home is that you can get a lower rate of interest than you can with an unsecured loan or credit card. However, if the interest rate offered for your refinanced mortgage is higher than your current rate, a home equity loan or line of credit might be a better choice.

Is mortgage refinancing right for you?
If you're refinancing in order to pay less interest, you won't usually see the savings right away. That's because lenders typically charge fees when you take out a new mortgage, and you may also have to pay a penalty for getting out of your old one. To determine whether refinancing makes financial sense for you, consider these issues:

• How long you plan to be in your home. If you expect to move in a year or two, you may never realize the potential savings you'd get from refinancing. As a rule of thumb, the longer you plan to stay in your current home, the more sense it makes to refinance.
• The prepayment penalty on your current mortgage. Many mortgages carry a penalty if you pay them off early. The amount varies, but it is usually a small percentage of the outstanding balance, or several months' worth of interest payments.
• The costs of the new mortgage. When you take out a new loan, your lender may charge a number of fees including application, appraisal, origination and insurance fees, plus title search, insurance and legal costs that can add up to thousands of dollars. Lenders may also charge discount points, which are paid upfront to secure a lower interest rate. As a guideline, expect fees to eat up any potential savings unless your new interest rate is at least a half a percentage point lower than your current one.
• The true difference in borrowing costs. When you're considering refinancing, remember that the posted interest rate doesn't reflect the entire cost of the mortgage. The amount you pay over the life of the loan will also be affected by the length of the term, whether your rate is adjustable or fixed, whether you paid discount points, and what upfront and ongoing fees you incur. One way to compare mortgage costs is to look at the annual percentage rate (APR), which takes into account not only the base interest rate, but also points and other charges. All lenders must follow the same rules when calculating the APR, so it's a good basis for comparison.
• Your reduced tax savings. If you claim mortgage interest on your tax return, refinancing to a lower rate will mean that you'll have less mortgage interest to deduct. You will still save money overall, but your real savings from refinancing may not be as large as you first believed. Consult a tax advisor who can help you understand the tax implications of refinancing.

The break-even point
In the end, deciding whether the cost of mortgage refinancing is worth it comes down to a simple question: "How long will it take before I start to save money?" In theory, this is a simple calculation. You start with the amount you will save by lowering your monthly payment. Then you add up all the costs associated with refinancing and divide the total by your monthly savings. This will reveal the number of months it will take to reach the break-even point.

For example, let's assume that refinancing would lower your payment from $1,000 to $800 (for a savings of $200 per month) and your prepayment penalty, closing costs and points add up to $5,000. Divide $5,000 by $200 and you'll see that it would take 25 months to realize the savings.

In reality, however, your break-even point also depends on other factors, including your tax situation and whether you pay closing costs upfront or add them to the principal of your new mortgage. If you are refinancing and your home has appreciated in value, you may also be able to save by canceling your private mortgage insurance.

For a more accurate estimate, use our refinancing calculator. Or consult a financial advisor who is familiar with your tax situation.