Is Refinancing to a Fixed Rate Home Loan Always the Right Choice?
Mortgage Credit Problems Columnist
Elizabeth Asks: Dear Gina, Some friends of mine recently refinanced their home loan to get out of their ARM and into a fixed rate mortgage. They told me that my loan was a time bomb and that I should refinance too. Are they right?
Gina Says:
Dear Elizabeth,
Your friends may have made the right decision for them. Lets see if it's the right decision for you. You need to consider several factors before making a decision to fix your interest rate.
What are the terms of your current mortgage? If you took out an adjustable rate mortgage (ARM) with unfavorable terms, like many bad credit ARMs in the past, you may be able to get significant benefits from refinancing. Check first and see if there is a prepayment penalty with your loan and make sure that you are beyond the penalty period. Look at the index, which is published and based on certain financial markets. Often, mortgages are based on the LIBOR or London InterBank Offered Rate, but yours may be based on another index--there are many.
Once you have your index, look in your loan documents for the margin. This is the percentage the lender adds to the index to get your total or fully-indexed rate. This shows you where your loan could adjust if it were doing so today. Many bad credit mortgage loans have very high margins: 5-8% rather than the 2-3% you'd expect from a prime mortgage. If yours is very high, you could probably see an immediate benefit if you refinance to a better loan. However, if you have a prime adjustable rate mortgage, your rate is probably around 4%, and there may be little urgency to fix it.
How long do you intend to keep your property? Refinancing can be expensive, and if you're not planning to keep your home for at least several years it might not pay off. Again, your loan documents can provide the answer. Look at your adjustment caps and your lifetime cap. If your rate increases once a year and can only go up by 1-2%, and you're only going to have the property for a couple of years, it probably doesn't make sense to refinance.
When does it always make sense to refinance? When you can refinance to a better rate with a "no-cost" mortgage, you have no break-even point and the savings begin immediately. This is highly likely if your current loan is a bad credit mortgage and you have improved your credit rating. If you plan to keep your home a long time, today's fixed rates are about as low as they get--you should definitely consider refinancing before they increase.
What have the last few years done to your credit? If you have been putting an episode of bad credit behind you and have a more respectable credit score, you may be able to save a lot of money. Moving up a few grades on the bad credit scale or qualifying for FHA or prime financing can knock hundreds off your monthly payment. Can you qualify? You don't know until you try, and its easy and fast to find out with today's automated underwriting systems.
Once you decide that refinancing is for you, it's time to shop for a lender. Compare rates, speak to loan agents, and work with the one who offers a good rate and makes you comfortable. It's easy to get mortgage quotes online--you can evaluate a lot more lenders in a lot less time.
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