Refinancing 101

Refinancing is the process of replacing your original mortgage with a new mortgage that has a more favorable interest rate and term. Many people choose to refinance when they have home equity (the difference between the amount owed to the mortgage company and the home's value). In other words, refinancing is paying off an existing loan with the proceeds from a new loan. Refinancing lenders typically require a percentage of the total loan amount, in the form of "points," as an upfront payment. One point equals 1 percent of the total loan amount. The more points, the better, because a larger payment upfront results in a lower interest rate.

Pros
Refinancing can reduce monthly payments and interest rates, and allow people to choose a different mortgage company or take cash out of their home preceding a large purchase. Homeowners can also cancel their private mortgage insurance (PMI) with a mortgage refinance loan, as the home's value increases and the balance on the home declines. Some people refinance to switch between an adjustable rate mortgage and a fixed one. For those with balloon programs such as ARMs, refinancing allows someone to switch to a new, fixed rate before the entire mortgage balance is due at the end of the term (usually five to seven years). One other reason for refinancing is to consolidate other debts into one loan.

Cons
However, there are risks involved. People may incur penalties that can amount to $1000+ for paying down their existing mortgage with home equity credit. Make sure you have an understanding of the fees involved before committing to refinancing. Fees can account for 3-6 percent of your outstanding principal and include the application fee, title insurance and title search, the lender's attorney review fees, homeowner's insurance, the appraisal fee, and points and fees incurred in loan origination. Your savings in interest must exceed refinancing fees in order for refinancing to be worthwhile.

Interested in refinancing? Experiment with the home refinance calculator. To learn more about refinancing a home, watch the short video below:

Determining Your Mortgage Payment

When buying a home, one of the most important factors is price. How much you can spend on a home depends on how much cash you can put down on a down payment, and how much money you can borrow. Before you begin looking for a home, seek pre-approval, based on credit and income, from a lender. Additionally, determine what you, personally, are comfortable paying. Your lender will be much less familiar with your lifestyle and future plans, and therefore will not consider some pertinent factors when approving you for a loan. Are you saving up for a family? Do you travel often? These are just a couple of questions you should ask yourself when generating your housing budget. To estimate your ideal mortgage payment, you can assess your current comfort level with your rent payment and look at your monthly income and expenses.

As a homeowner, your housing payment includes:

• Principal 
• Interest 
• Property taxes 
• Homeowners' insurance. 

Additional expenses:

• If you put less than 20 percent down on your home, you will have to pay mortgage insurance. 
• At least 1 percent of the home price should be set aside for maintenance and repairs.
• Some homeowners need to pay homeowner association dues (HOAs) or condominium fees. 

Lenders will look at your debt-to-income ratio when approving a loan. Most lenders won't approve loans with a ratio higher than 41-43%. You can use a mortgage calculator to help determine your debt-to-income ratio. Essentially, you'll want to divide your gross monthly income (all income documented by paystubs or tax returns) by your monthly debt payment (new housing payment and minimum monthly payment on outstanding debt, such as a credit card, a car loan, or child support).

Aside from income and debts, lenders will also look at:

• Assets
• Downpayment
• Credit score 
• Job history 

Your mortgage payment depends on your loan term and interest rate. A shorter loan term generally has a lower interest rate; however, it also means higher monthly payments. Interest is also affected by credit score. A higher credit score means a lower interest rate. Ultimately, a good lender can evaluate your personal circumstances and make recommendations for a loan program based on your individual financial needs.