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Mortgage rates » rates

Everything You Need to Know About Refinancing Mortgages

$100 bills To refinance a mortgage means to pay off an existing loan by replacing it with another loan. Refinancing may be a wise financial move if it will reduce your mortgage payment, shorten the term of your loan or help you build equity more quickly. When used carefully, it can also be a valuable tool in getting your debt under control.

Refinancing mortgages is common for homeowners in the United States. People usually refinance for a number of reasons; to obtain a new loan with interest rates, to shorten mortgage term, to convert an adjustable rate mortgage (ARM) to a fixed rate one or to convert a fixed rate mortgage to an adjustable, to use a home’s equity to finance another purchase, or to consolidate a debt.

Two factors are involved in refinancing mortgages: money and time. Generally, the more money you can pay upfront, the lesser you need to pay in the long term. Similarly, the more money you need now or the lesser money you can pay upfront, the more you need to pay in the long run.

A, B, C - alphabetLearning the Vocabulary of Mortgage Refinancing

“Points”

Refinancing lenders usually require a certain percentage of the total loan amount as an upfront payment for the processing of mortgage refinancing. This amount is usually expressed in “points” or “premiums.” Each “point” is equivalent to 1% of the total loan amount, so if you choose a plan that requires paying three points, then you will need to pay 3% of the total loan amount upfront. Refinancing lenders usually offer various combinations of points and interest rates that may suit a borrower’s needs. If you pay more “points” upfront, you would usually be allowed to acquire lower interest rates. “Negative points” (or discounts) means that the lender finances part of the loan.

“Cash-out” refinancing

After paying mortgage for a while and if your property appreciated in value, you should have built up some equity in your home. You can access this equity as money through a cash-out refinancing. Say for example your house is worth $200,000 and you still have an outstanding loan balance of $100,000 on your mortgage. You can refinance your mortgage for $150,000 and take the $50,000 as cash from the equity in your home.

“No-cost” Refinance

A “no-cost” refinance is a loan in which you do not have to pay for the refinancing cost upfront and the cost of refinancing is recovered by your lender by adding to your interest rate. The cost of the refinancing transaction would just be built into the interest rate.

“Break-even point”

If you choose to refinance to a lower interest rate mortgage, you will end up saving money each month by lowering your monthly payment– that is if the other loan terms do not change. Since it also costs money to refinance, it is important to determine the break-even point by taking your total transaction costs and divide by your monthly savings. For example, if you save $100 a month by refinancing and the closing costs to refinance is $3,000, you divide the $3000 by 100 and your break-even would be 30 months or two and a half years from the time you refinance.

mortgages and refinancingWhen and why do we need to refinance mortgages?

To secure lower interest rates on existing loans.

If you can reduce your interest rate by at least 2%, by rule of thumb, it is usually worth it to refinance. Some lenders even say that a 1% decrease is worth refinancing.

Reducing the interest rate will save you more money in the long run and will increase the rate at which you build equity and decrease the amount of your monthly payment. For example, a loan of $100,000 with an interest rate of 9% on a 30-year fixed-rate mortgage will cost you principal and interest payment of $804.62. The very same loan, if refinanced at a lower rate of 6% interest will decrease your payment to $599.55.

To shorten the Loan’s Term

Sometimes, it is also worth it to refinance even if the monthly payment barely changes as long as the term of payment shortens. For example the 30-year fixed-rate for the $100,000 loan on a 9% interest rate, if refinanced to a 5.5% interest will cut the term in half and only increase the monthly payment by a bit more that $10.

To convert from Adjustable-Rate to Fixed-Rate Mortgages or Vice Versa

Usually, adjustable rate mortgages offer lower rates than fixed rate mortgages although there are situations when the fixed-rate mortgage ends up being a better deal. In these cases it is better to refinance to a fixed-rate with a lower interest rate at the same time, securing yourself from any interest rate hikes in the future.

Sometimes, the better strategy is to convert from a fixed-rate interest loan to an adjustable rate mortgage especially if rates continue to fall. It is good to observe the trends and go for a conversion especially if you, as a home owner, do not plan to stay long in your home. This way, you would not have to always refinance each time there is a drop in the interest rates. Also, if you only stay in the home for a few years, it is less likely for you to suffer an interest rate hike. This will surely lessen the interest rates and the monthly payments.

To Tap Equity and to Consolidate Debt

To refinance for the purpose of tapping home equity and consolidating debt, it is important to really consider all the factors to avoid falling in the trap of never-ending debt.

Tapping Home equity for a “cash-out” refinancing is when you refinance for a particular amount higher than one’s current principal balance giving you extra cash for immediate needs. Usually home equity is accessed to cover huge expenses like paying children’s tuition fees or remodeling homes. Some say that home remodeling actually adds value to the home although the rates can still be tricky and the plan needs to be carefully reconsidered.

To consolidate a debt, especially by replacing a high-interest rate with one with a lower interest rate is pretty sound. However, this is ideal for those who can maintain financial prudence and avoid the temptation of maxing out on credit limits. Studies show that a rather large percentage of people who once generated high-interest debt on purchases and credit cards usually fall in the same cycle especially if mortgage refinancing gives them the available credit. If this happens, it is really more of a loss to keep on paying application fees to refinance, adding years to the term, or worse, losing equity in the house.

An added bonus for refinancing is to get rid of PMI. Usually homeowners who were unable to give a 20 percent down payment when they purchased their homes may have been required to purchase Private Mortgage Insurance (PMI). If the homes have appreciated since the time of purchase, as mortgage is paid consistently, the homeowners’ equity may actually be more than 20 percent by the time they refinance. For this reason, they wouldn’t need to purchase a PMI.

AttentionRisks

It is important to study closely the pros and cons of mortgage refinancing to make sure you get the best out of it.

Refinancing may cost 3% to 6% of your loan’s principal and it requires application fees, appraisal and such. Sometimes, the total of these fees outweigh the total savings generated through refinancing the loan.

Moreover, take note that many fixed-term rate debts have penalty clauses called “call provisions” which may be triggered by an early payment of the loan or at least a specified portion of it.

Also some mortgage refinancing loans may have lower initial payments but may actually result in larger total interest costs over the entire lifespan of the loan. Make sure to calculate the up-front, the ongoing, and even the potentially variable costs of mortgage refinancing to make sure you cover all risks.

Bingo - light bulbHere are some valuable tips when considering mortgage refinancing:

  1. Ask yourself, “How much money will I actually save?” Make sure that the efforts and the application fees would be worth the extra money you will save. Again, refinancing will surely cost you three to six percent of your loan’s principal.
  2. Ask yourself this also: “How long do I plan to live in the house?” Remember, if you save up a few dollars on your monthly payment and yet, not stay in the house long enough, the cost of refinancing will actually work against your plan of saving in the long run.
  3. Think realistically and practically considering your finances closely. Look into what you can and can’t afford to make sure you are not just entangling yourself into more debt.
  4. Learn the law. There are federal protections instituted to avoid lenders from exploiting borrowers. To know what’s legal or not will help you sort through the unscrupulous lenders from the good ones.
  5. Don’t settle with a lender immediately. Look around and ask around. Make sure to ask knowledgeable people and if possible, ask for quotes from various lenders. By comparing the deals, you can decide on the best lender.

Compute. Some deals may sound and good at face value but actually may not be beneficial in the long run and conversely, some deals seem to offer trivial discounts but may actually give better results on a long term basis. Make sure to compute how much you will benefit in five, ten or even twenty years.

US Mortgage Rates: An Overview

The average American family usually has two or more mortgages and with this information, we can sense that the modern world looks at the term mortgage as a family’s purchasing factor in obtaining a home. Looking at the real meaning of this business term, mortgage is, in fact, a simple process wherein a person or a business entity can acquire any given residential or commercial property without having to pay for the entire value immediately (this is also known as a loan). When the mortgage is approved, the real estate also becomes collateral.
To be able to understand how mortgage rates are being computed, it is imperative to understand the determining factors such as the role of the
U.S. economy, the processes involved in this major category of U.S. business, and the function of the market as a whole. The Federal Housing Administration is the one that administers the Ginnie Mae Fannie Mae and Freddie Mac program (also called as GSEs or Government Sponsored Entities). This program works by purchasing a huge volume of mortgages from banks and issuing the bonds that are backed by mortgages (Mortgage Backed Securities) to investors.

The Process in US Mortgages

Nowadays, the course of action in obtaining mortgage is simple—borrowers are being offered by many banks to submit just a few financial documents (this, however, would pre-determine a higher interest rate). The ‘no document’ or ‘low document’ loans are only being offered to people who have astoundingly excellent credit.
There are loans that are sometimes being sold to large investors on the open market. Some correspondent lenders sell most or even all of their closed loans to these large investors even with some issuing risks. More or less, these are the determining factors that comprise how high or low an interest rate would be.

Type of Mortgage

Tenure

Interest Rates (%)

Ratio of Loan to Value

Maximum Loan Tenure

Fixed Rate Mortgage 15 Years 5.36 80% 30 Years
30 Years 6.05
Floating Rate Mortgage 1 Year 3.79

This chart should be able to provide a basic idea of what the current average rates are for the different types of mortgage in the U.S.

The Most Prevalent Mortgage Interest Rates

Fixed Mortgage rates boast of non-volatile principal and monthly payments for interest. This means that these factors do not change throughout the entire duration of the mortgage. For as long as the borrower remains on a fixed term agreement, the interest rates do not vary. The major advantage to taking this type of mortgage interest rate is that the borrower is able to keep track of the precise amounts of his payments. With this type of interest rate, the borrower would be able to manage his budget more easily.
It is best to settle for this type of mortgage interest rate when the rates have an upward trend. This is because fixed rate mortgages pin the present rate and the borrower would never have to worry of any uncertainties on interest rates in the future.
Adjustable mortgage rates are mortgage interest rates that are volatile. These rates can be adjusted from time to time depending on the current trend. It is best to go for this type of mortgage interest rate when the interest rates are at a downward trend. The periodic changes on an adjustable mortgage rate could be done annually, or every three or five years. With this rate, the borrower could easily take advantage of the new rates that are much lower than the first rates.

History of Mortgage Rates for the Last Five Years

To better understand the trend of interest rates, it is important to know the history for the past years, the most recent quarters, and also the rate of fluctuation. Once these are established, economists are better able to predict the upcoming interest rates.
Here is a comprehensive history of the average rates for FRM (Fixed Rate Mortgage) and ARM (Adjustable Rate Mortgage). These are based on the computations for the last five years that were made by the HSH Associates Financial Publishers (a publisher of consumer loan information for almost three decades); this comprises Figures 2-6. The following link may be accessed for information on rates that can go as far back as twenty years (http://www.hsh.com/mtghst.html):

Date

15-Year FRM

30-Year FRM

1-Year ARM

Jan-03

5.48%

6.05%

4.26%

Feb-03

5.36%

5.94%

4.15%

Mar-03

5.25%

5.88%

4.04%

Apr-03

5.28%

5.92%

4.02%

May-03

5.24%

5.65%

3.89%

Jun-03

4.84%

5.43%

3.75%

Jul-03

5.14%

5.80%

3.80%

Aug-03

5.77%

6.47%

4.08%

Sep-03

5.58%

6.29%

4.10%

Oct-03

5.41%

6.12%

3.98%

Nov-03

5.40%

6.07%

3.99%

Dec-03

5.35%

6.03%

3.97%

Interest Rates for the Year 2003

Date

15-Year FRM

30-Year FRM

1-Year ARM

Jan-04

5.20%

5.88%

3.83%

Feb-04

5.10%

5.76%

3.72%

Mar-04

4.91%

5.59%

3.56%

Apr-04

5.29%

5.96%

3.77%

May-04

5.77%

6.40%

4.09%

Jun-04

5.81%

6.42%

4.25%

Jul-04

5.61%

6.20%

4.22%

Aug-04

5.41%

6.01%

4.14%

Sep-04

5.28%

5.88%

4.08%

Oct-04

5.25%

5.84%

4.05%

Nov-04

5.26%

5.83%

4.18%

Dec-04

5.27%

5.83%

4.23%

Interest Rates for the Year 2004

Date

15-Year FRM

30-Year FRM

1-Year ARM

Jan-05

5.27%

5.80%

4.35%

Feb-05

5.26%

5.72%

4.36%

Mar-05

5.54%

6.01%

4.51%

Apr-05

5.58%

6.02%

4.60%

May-05

5.43%

5.87%

4.53%

Jun-05

5.35%

5.77%

4.57%

Jul-05

5.41%

5.84%

4.73%

Aug-05

5.58%

6.00%

4.89%

Sep-05

5.52%

5.94%

4.89%

Oct-05

5.77%

6.21%

5.11%

Nov-05

5.99%

6.44%

5.30%

Dec-05

5.95%

6.39%

5.37%

Interest Rates for the Year 2005

Date

15-Year FRM

30-Year FRM

1-Year ARM

Jan-06

5.86%

6.28%

5.38%

Feb-06

6.02%

6.40%

5.47%

Mar-06

6.12%

6.47%

5.65%

Apr-06

6.28%

6.63%

5.82%

May-06

6.37%

6.75%

5.92%

Jun-06

6.38%

6.83%

6.03%

Jul-06

6.53%

6.88%

6.16%

Aug-06

6.32%

6.63%

6.04%

Sep-06

6.16%

6.49%

5.98%

Oct-06

6.13%

6.47%

5.94%

Nov-06

6.04%

6.34%

5.92%

Dec-06

5.94%

6.23%

5.84%

Interest Rates for the Year 2006

Date

15-Year FRM

30-Year FRM

1-Year ARM

Jan-07

6.05%

6.33%

5.91%

Feb-07

6.11%

6.37%

5.94%

Mar-07

5.99%

6.27%

5.89%

Apr-07

6.05%

6.35%

5.91%

May-07

6.08%

6.39%

5.91%

Jun-07

6.41%

6.73%

6.04%

Jul-07

6.50%

6.85%

6.12%

Aug-07

6.59%

6.96%

6.22%

Sep-07

6.49%

6.83%

6.29%

Oct-07

6.38%

6.72%

6.21%

Nov-07

6.22%

6.56%

6.02%

Dec-07

6.16%

6.61%

6.00%

Interest Rates for the Year 2007
The figures above show that the rate for ARM has played from a low of 3.56% in March 2004 up to 6.29% in September 2007. The 15-year FRM rates play between 4.84-6.53%; the 30-year FRM is recorded at 5.43-6.96%.

Factors Affecting the Interest Rates According to the Experts

The year of 2007, up until the first quarter of 2008, has been highly unstable for the economy of the United States. Most economic experts believe that the U.S. economy is at the brink of recession despite the interventions that are being made by the United States Central Bank and Treasury. As of the end of April 2008, the unemployment rate has gone up once more at 5.1%. Although this is the case for the rate of unemployment in the country, the interest rates have managed to go down by 2.25% which is a welcome surprise despite the plunging economy. To add to this, the budget deficit went up by $357 billion.
In the past few years,
United States had an economy that continuously climbed. This does not present a remedy, though, for the dilemma that was presented by the credit and housing markets. These two sectors have hit an all-time-low over the past quarters (most especially on the end of the year 2007). Economists made forecasts that the U.S. economy would plunge some more and it would even experience a mild recession by the first half of the year 2008.

Graphic chart

This is a chart of the United States Economic Growth since the year 2003 up to the first quarter of 2008.
The figure above shows the peak on the third quarter of 2007 and the prediction (pink bar as opposed to the red bars of the previous quarters) shows a constant decline from the big dip on the fourth quarter of 2007. Looking at this trend, it is most likely that the losses would eventually affect the interest rates in the market.
There is yet, another factor on the current volatility of the U.S. economy. David Beadle, a mortgage industry analyst, has expressed his opinions the role of the ever-increasing prices of gasoline. It has been observed that despite the efforts of some American motorists to cooperate on the reduction of gasoline consumption, the prices seem to be steadily climbing.
The uphill trend of gas prices seem to be affected not only by the international trend on market prices but also by the U.S. government’s effort to reduce the currency value to be able to balance the trade relations between some countries and the U.S. Gasoline price is a large determining factor for interest rates and all other business rates all over the globe. Once this aspect becomes uncontrolled, it would most probably lead to economic recession.
US inflation rate

Chart of United States Inflation Rate According to the Department of Labor.

The figure above explains that the United States economy is also facing challenges on inflation. There have been pressures on record oil prices and this propelled the petrol and heating oil prices. Inflation above 2% is usually an alarming rate (although the United States Central Bank has not specified any inflation target).

US Unemployment Rate

The United States Unemployment Rate Chart from the year 1998 to the first quarter of the 2008.

The sudden drop on the country’s economy has led to the gradual increase on the unemployment rate. The unemployment rate was higher than what it used to be at the last stage of the 1990s boom.

The months of October until December 2007 showed an increase in American exports which also made the domestic real estate activity decline. The ‘Easy Money Policy’ of the Federal Reserve has greatly affected the interest rates and the Fed has begun to feel economic pressure from most experts as these people rally to end the said policy. If the Federal Reserve fails to answer to this call, bond market traders may try to solve the problem on their own and this would result into higher Treasury yields; and higher yields mean skyrocketing mortgage rates!

A five-year low for the U.S. consumer confidence has been recorded in April 2008. The same record also shows homeowners who are falling behind with their mortgage payments. The future of mortgage rates depends greatly on what would happen with the U.S. economy. It is a simple mathematical equation, actually—the more the economy slumps, the higher the rates go; the more it improves, then the rates are sure to take the dip.

Empowering the Average American

When the economy plunges and mortgage rates take a step up, the most ‘victimized’ individual is the average Joe who has probably two or more mortgages to take care of. Since the economy is never predictable, it is very important that the middle-class family, with mortgages under their sleeve, take charge of the things that they have control over.

Being in the market and looking for a home requires ample finances (or at least a source of steady income) and wisdom in making the necessary real estate decisions. Always put in mind that the best rates go to the people who deserve them (a.k.a. those who have great credit scores), to those who have made down payments that are highly substantial, and those who have great control over their income and their debts.

Here are some tips on how to stay afloat amidst the crisis (whether it is national or personal!):

  1. Average Joe should pay for his bills before the due date. Most lenders prefer that their borrowers know how to make on time payments. A record that shows a borrower who can constantly pay monthly dues attracts lenders. These lenders see risks in a payment that has been skipped, late payments (even if the payment has been made just a day after the due date), more so in months of non-payment. Remember that the bigger the risks that these lenders see, the higher the mortgage rates would be. Take note, too, that a check that has been delayed a couple of weeks or even a few months before the mortgage application would be present a ‘red flag’ to most lenders.
  2. Average Joe should make larger down payments. It is common knowledge among lenders that the larger the down payment is, the less likely that the borrower would default. Do not hesitate to dip into that precious savings account if only to lower the mortgage rates. Adding more amount would definitely lower the interest rate (and a quarter-point or so of reduction is worth the try).
  3. Average Joe should try to reduce his debts. All lenders peruse the amount that each mortgage applicant owes, even his monthly payments. These lenders want to make certain that the applicant is able to take care of his present bills else it will affect his future payments with the mortgage that he is applying for. The chances of being approved for the mortgage also go higher as the applicant’s debts are lessened. With less bills to take care of, it is common sense that the applicant will be better able to take care of future mortgage payments. Reducing debts do not only improve the chances of getting the mortgage but it would also improve the person’s credit score. This is best for those who have debts acquired with the use of credit cards and a record that reflects a bouncing amount due against the credit limit. A credit card debt that is 50% lower than the available credit would appear ‘appetizing’ to the lenders’ eyes. Remember this: the lower the amount of debt, the better chances you have of being approved for mortgages that you are applying for!
  4. Average Joe should not apply for additional consumer loans and more credit cards. If lenders see many credit cards under a certain name, they are highly prompted to check on the name and its credit history. When the lenders do this, their inquiries are automatically noted on the credit score of the applicant. A single inquiry could lower a credit score by as much as 12 points (and each point is a determining factor on whether to approve a certain applicant or not).
  5. Average Joe should scout around for the best interest rates. The best approach is to ask for realistic quotes from lenders. Having three lenders do the estimate would be a good move. Do not just focus on the present bank or lender, or the mortgage broker that is nearest to your residence. A person who would be able to acquire a mortgage broker that his family already knows or has done business with would be able to obtain a good interest for his upcoming mortgage. Having a trusted mortgage broker assist on an individual’s plans would be a great help in obtaining an interest rate that would not slash the borrower’s pockets.
  6. Make use of mortgage calculators. What are these tools, anyway? There are so many sites that offer this helpful tool and yet, not too many people are aware of how useful it can really be. A mortgage calculator is a tool which can help an individual decide on how much money he can use or borrow to be able to acquire real estate. These calculators are often utilized to compare interest rates and costs among loans. The use of this tool would also determine the effect of the length of years that a certain mortgage would last against the principal payment and the subsequent payments. The variables that are commonly affected are the following: principal balances, frequency of payment, interest rates, and amount of payments.

Before mortgage calculators were used by buyers, most of them would use interest rate tables so that they can determine the effect of the variables on a certain mortgage transaction. These tables required know-how on compound interest math which is not all-too-common for the regular man. Mortgage calculators have then eased this burden—all that a buyer would have to do is to fill in all the amounts on the proper fields and—voila—the results would be shown in a second.

Predicting the Rates like a Pro

Perhaps, the average American would also want to be able to make intelligent predictions when it comes to the trend of mortgage interest rates. Economists make their predictions out of mathematical calculations (and some luck!) and knowledge on economic laws. And since mortgage rates are the most important part to consider before taking the actual loan, it is best to know how the experts predict the unpredictable:

  1. Before being able to predict whether the mortgage interest rates would be climbing up or plunging down, it is always best to know the factors that affect the trend. These factors have been discussed previously (prices of certain commodities and the economy of the country as a whole). Also, the stock market and the foreign exchange market have a major effect on the movement of mortgage rate interests.
  2. When the stock market does very well, more investors would want to put in their money on the market. This would mean fewer lenders that would provide mortgages. The interest rates would go up once the demand still calls for mortgages despite the low number of lenders. If, on the other hand, the stock market is not doing so well, the rates would plummet as more lenders would be willing to have their money borrowed.
  3. This same principle is true with the Forex market.

To be able to come up with a good decision on your first or on your next mortgage, it is always important to be armed with ample information such as the current trend, the interest rate history for the past few years or quarters, even calculating the risks with the help of some tools such as the mortgage calculator.

But above all, the most potent weapon that you should be armed with is a good credit score. Work on this and the lenders would be the ones to offer the best rates in the market. Interest rates—they will forever be affected by many factors—and yes, no one can totally predict what the mortgage interest rates would precisely be!