|Your Old Mortgage
|Home price:|| $|
|Down payment:|| $|
|Original loan amount:|| $||Original APR:|| %
|Original loan term:|| years|
|Time left on original:|| months|
$1,643.38 Monthly Payment
$978.03 Monthly Payment
$220,417.93 Remaining Loan Balance
$200,000.00 New Loan Balance
Original Total Loan Cost
Remaining Interest on Old Loan
$152,092.37 Interest Expense on New Loan
(plus $5,200.00 in closing costs)
Monthly Savings from Refinancing
$4,000.00 Cost of Discount Points
$1,200.00 Other Closing Costs
$16,700.15 Total Savings By Refinancing
$5,200.00 Total Closing Costs
Mortgage Consolidation & Refinancing Calculator
Use this calculator to see if it makes economic sense to refinance a mortgage or consolidate a first & second mortgage into a single monthly payment. This calculator will determine:
- the monthly payment for your new loan
- the net interest savings
- the number of months until you will break even on the closing costs
Enter Principal and Interest Payments Only
When entering your current loan information, please include the principal & interest (P&I) portion of your monthly payments. Do not include the escrow portion (property taxes & homeowners insurance) of the payments or else it will throw off our calculations. If you are uncertain, your mortgage statement should show how much of your payment was applied toward the loan versus escrow expenses.
Current Mortgage Refinancing Rates for a $200,000 Home Loan
The following table highlights current mortgage rates. By default -year loans are displayed. Clicking on the purchases button switches loans from refinance to purchase. Other loan adjustment options including price, down payment, home location, credit score, term & ARM options are available for selection in the filters area at the top of the table. The "Product" selection menu lets you compare different loan terms like 15 or 30 year fixed rate options & other lending options like 3/1, 5/1 & 7/1 ARMs or even IO ARMs.
An Introductory Guide to Mortgage Refinancing
So you’ve managed to take a mortgage and move into a new home. After a couple of years, you’re now wondering if there’s anything you can do to improve your mortgage deal. In particular, you’re thinking of changing your current rate and term. You’ve noticed general market rates are low, and you’re thinking of securing a more favorable rate. If this is the case, it’s definitely possible through mortgage refinancing.
Our article will discuss how mortgage refinancing works, together with its requirements and costs. We’ll explain when it’s a good idea to refinance your mortgage and how this can boost your overall savings.
Apart from rate and term refinancing, borrowers also have the option to take cash-out refinances to tap home equity. We’ll also discuss other ways to access home equity, such as HELOCs and home equity loans, which are also called as second mortgages. Then, we’ll explain how mortgage consolidation refinancing works and when it’s beneficial to merge your first and second mortgage.
What is Mortgage Refinancing?
Refinancing is taking a new loan to replace your current mortgage. This lets borrowers obtain a lower rate and change their term. If you got a higher rate the first time you took your mortgage, refinancing can secure a more favorable rate. With a better deal, you’ll save more on interest costs over the life of your loan. Refinancing is ideal when market rates substantially fall and if you plan to stay long-term in your house.
You may also take a cash-out refinance option, which allows you to tap a portion of your home equity. You can use this money to fund home improvement projects or other important expenses. If you take a cash-out refi, you’ll borrow more than you owe on your existing loan. The difference between your current mortgage balance and your new loan is the amount you obtain or cash-out.
However, note that taking a cash-out refi will increase your outstanding balance. It also has loan limits, which is why you need significant home equity before you take this type of loan. To learn more about cash-out refinancing, visit our guide on the cash out refi calculator.
Refinancing Qualifications & Closing Costs
Because refinancing is essentially applying for a new mortgage, it comes with certain requirements. Before taking a refi, borrowers should review their credit score, loan-to-value ratio, and funds for closing costs. Take note of the requirements for each key factor:
Loan-to-value Ratio (LTV)
LTV ratio is an indicator that compares your mortgage amount with the current appraised value of your home. Lenders use it to gauge the level of risk they are taking before they approve your mortgage. Loans with high LTV ratio, which are close to the appraised value of the property, are considered to have greater default risk. Meanwhile, loans with lower LTV ratio which are 80% LTV and below, incur less risk. Thus, low LTV ratios receive higher chances of approval from lenders.
LTV is determined by taking the loan amount and dividing it by the current appraised value of the property. For example, suppose your house is priced at $350,000 and your loan amount is $280,000. To calculate LTV, we’ll divide $280,000 by $350,000. This results in an LTV ratio of 80%.
LTV ratio = Loan Amount / Appraised Value of Property
= $280,000 / $350,000
= 0.8 * 100
LTV = 80%
To achieve 80% LTV on a $350,000 home, you paid 20% down, which is equal to $70,000. Having a lower LTV ratio means you have greater equity on your home. This shows how much of the home’s value you’ve paid on your mortgage. Borrowers increase their home equity while reducing LTV ratio by paying a significant amount of down payment. LTV ratio also decreases the more payments you make on your mortgage.
Aim for 80% LTV of Less
You must build substantial home equity before you can refinance. To be eligible, most conventional loan lenders prefer an LTV ratio of 80% and below (20% home equity). This automatically removes private mortgage insurance (PMI) on conventional loans. PMI is a mandatory fee when your LTV ratio is higher than 80%. It typically costs 0.25% to 2% of your loan amount per year, and is canceled once your LTV ratio reaches 78%.
But depending on your lender, some may allow up to 90% LTV. But note that a higher LTV ratio comes with PMI charges for conventional loans. So aim for 80% LTV or less when you apply for refinancing.
Borrowers must satisfy the credit score requirement, which is 620 to refinance into a conventional loan. But to ensure a lower rate, you must have a high credit score of 700 and up. The higher your credit score, the more favorable your rate. This helps boost your loan’s interest savings. Obtaining a low enough rate can also help reduce your monthly payments.
On the other hand, government-backed mortgages offer more flexible credit standards compared to conventional mortgages. Take note of the following credit score requirements for each government-sponsored mortgage program.
Government-backed Loan Refis
FHA Loans: If you’re applying for a cash-out refi, your credit score must be 580 and above. However, note that most FHA-sponsored lenders prefer borrowers with a credit score of 600 to 620. FHA cash-out refinances allow up to 80% LTV. You may secure refinancing through the FHA streamline refinance program.
VA Loans: Mortgages specially given to veterans, active military, and qualifying military spouses are called VA loans. They come with flexible credit requirements, but most VA-sponsored lenders prefer a credit score of 620 and up. You must have a current VA loan to apply for the Interest Rate Reduction Refinance Loan (IRRRL) program. VA cash-out refinancing allows up to 90% LTV.
USDA Loans: Borrowers with USDA direct and guaranteed loans can apply for the USDA streamlined assist refi program. This does not require income qualifications or credit score reviews. To be eligible, your mortgage should be paid for the last 12 months before enrolling for a refi. The USDA program only provides rate and term loans. They currently do not offer cash-out options for borrowers.
Budget for Closing Costs
Besides the strict LTV and credit score requirement, refinancing entails costly expenses. Refinancing closing costs typically range from 3% to 6% of your loan amount. For example, if your loan is $220,000, your closing cost can be around $6,600 to $13,200. This is a large sum, so prepare your budget before taking a refi.
Refinancing closing costs are also affected by mortgage points. Take note of the following mortgage points and how they can affect your expenses:
Origination Points: These are upfront fees you pay for the processing, analysis, and approval of your mortgage. Origination fees are required by lenders to cover your loan officer. These are based on a percent of the loan amount, which is usually around 0.5% to 1%. Origination points are negotiable, so to talk to your lender to help reduce your refinancing costs.
Discount Points: You can purchase discount points from your lender to lower the interest rate on your mortgage. As a result, it reduces the overall interest charges of your loan. Paid as an upfront fee, discount points are most favorable when you plan to stay long-term in a home. One discount point is typically 1% of the loan amount. For instance, 1 point on a $250,000 loan is $2,500. A half point is $1,250, and a quarter point is $625.
Discount points vary per lender and are ideally paid upon closing. Though it can be rolled into your mortgage, it increases your loan amount. A higher loan amount results in higher monthly payments. It will also take you longer to reach a breakeven point, which is the time it takes recoup the cost of refinancing.
Next, prepare the following documents before applying for refinancing:
- Tax returns, W-2 and 1099
- Last 30 days of pay stubs
- 1 year of bank statements
- Most recent credit report
- Latest home appraisal
You’ll notice that refis require similar documents as purchase home loans. For this reason, consider refinancing with your original mortgage lender. Besides the convenience of familiarity, it will help you obtain a much better rate and term compared to changing to a new lender.
Adverse Market Refinance Fee
The COVID-19 pandemic drove the global economy into a recession in 2020. Fannie Mae and Freddie Mac, which sponsors around 70% of mortgages, lost an estimated $6 billion to the crisis. In response, they required mortgage originators to charge an adverse market refinance fee of 50 basis points. The rule officially took effect in December 1, 2020 for all borrowers applying for refinances. Those exempted are borrowers with balances lower or equal to $125,000, as well as FHA and VA refinances. Take note of this extra charge.
When Is Refinancing Beneficial?
Ideally, you should refinance to secure a significantly lower rate, at least 1% to 2% lower than your original rate. This will substantially reduce your loan’s interest charges, which saves tens and thousands of dollars over the life of the loan. It’s the reason why more people tend to refinance when general market rates are low. Such was the case during the 2020 refinancing boom, as the Federal Reserve kept benchmark rates near zero to uphold market liquidity.
Furthermore, it’s beneficial if you can refinance into a low rate and shorter term, such as a 15-year fixed mortgage. However, note that refinancing into a shorter term usually results in higher monthly payments. It’s best to gauge if your budget can afford it. And since refinancing entails expensive costs, it’s more suitable for people who intend to stay for a long time in their home. If you’ll move after a few years, refinancing is not a practical option.
On the other hand, ask about prepayment penalty before refinancing. Changing to a more favorable rate is disadvantageous to lenders, especially during the first few years of the loan. They lose interest profits they could have earned if you kept your original loan. To discourage early refinancing, lenders implement prepayment penalty charges.
Beware of Prepayment Penalty
Prepayment penalty is a fee charged by lenders to hinder borrowers from selling, refinancing, and paying their mortgage early. It’s an expensive fee that’s around 1% to 2% of your loan amount. Prepayment penalty typically lasts for the first three years of a mortgage. To avoid this expensive cost, you can refinance after the penalty period has ended. By that time, you should have a lower LTV ratio to qualify for refinancing.
Depending on your lender, you can obtain a conventional mortgage without a prepayment penalty clause. Government-backed mortgages such as FHA loans, VA loans, and USDA loans also do not impose prepayment penalty charges.
Calculating Refinancing Costs
To check if refinancing is a practical option, you should estimate the cost. Using the above calculator, let’s review the following example. Suppose you bought a house worth $300,000 with 20% down ($60,000), and you took a 30-year fixed mortgage at 5.5% APR. Five years later, your principal loan amount is $221,905.41 and you want to refinance into a 15-year fixed mortgage at 4.2% APR. You purchased one discount point and your origination point is 0.5% of the loan amount. Let’s see how much your refi will cost.
Home Price: $300,000
Down Payment: $60,000
Original Loan Amount: $240,000
Original Loan Term: 30 years
Original Rate (APR): 5.5% APR
Remaining Monthly Payments: 300
Refinance Loan Amount: $221,905.41
Refinance Loan Term: 15 years
Refinance Rate (APR): 4.2%
Discount Points: 1%
Origination Points: 0.5%
Other Closing Costs: $2,220
|Loan Details||Original Mortgage||Refinanced Loan|
|Monthly P&I Payment||$1,362.69||$1,663.74|
|Total Mortgage Payments||$490,569.70||$305,021.16|
|Total Interest||$186,902.63||$77,567.17 (including closing costs)|
This calculation did not include escrow costs.
|Cost of Discount Points||$2,219.05|
|Cost of Loan Origination Point||$1,109.53|
|Other Closing Costs||$2,220.00|
|Total Closing Costs||$5,548.58|
According to our calculation, if you refinance your 5.5% mortgage at 4.2% into a 15-year fixed mortgage, your monthly principal and interest (P&I) payment will increase to $1,663.74 from $1,362.69. That’s an added $301.05 to your monthly mortgage payments.
Your total closing costs on the refinance will be $5,548.58 and you’ll spend $77,567.17 in total interest on the new loan. This compares to $186,902.63 in interest left on your original mortgage, which results in a net savings of $103,786.88 by refinancing. This example shows you’ll save a substantial amount on interest charges if you refinance to a shorter term and lower rate.
In some cases, refinancing may result in more affordable monthly payments, making your budget more manageable. However, this is not advisable if it will further extend your term, especially if you’ve been paying your mortgage for a long time. It’s more favorable to refinance into a shorter term to pay your mortgage early and save on interest charges.
For instance, you’ve been paying your 30-year fixed mortgage with an original loan amount of $260,000 at 6.5% APR for 10 years. If you refinance into a 30-year term at 5.2% APR, this will decrease your monthly payments. However, you’ll end up paying more expensive interest charges. You also prolong your mortgage debt well into your senior years.
To understand how this impacts your mortgage expenses, review the example below.
Home Price: $325,000
Down Payment: $65,000
Original Loan Amount: $260,000
Original Loan Term: 30 years
Original Rate (APR): 6.5%
Remaining Monthly Payments: 240
Refinance Loan Amount: $220,417.92
Refinance Loan Term: 30 years
Refinance Rate (APR): 5.2%
Closing Costs: $1,200
|Loan Details||Original Mortgage||Refinanced Loan|
|Monthly P&I Payment||$1,643.38||$1,210.34|
|Total Mortgage Payments||$591,615.67||$436,921.96|
|Total Interest||$173,992.52||$215,304.04 (including closing costs)|
This calculation did not include escrow costs and mortgage points.
Based on our calculations, if you refinance your 6.5% mortgage today at 5.2% into a 30-year fixed mortgage, your monthly principal and interest payment will decrease from $1,643.38 to $1,210.34. That’s lower by $433.04 on your monthly mortgage payments.
However, you’ll spend $215,304.04 in total interest costs on the new loan. This is higher compared to $173,992.52 of interest left on your original mortgage. In this example, refinancing to a longer term will cost you $41,311.52 more over the life of the loan.
Changing from an ARM to a Fixed-rate Mortgage
You may refinance to shift from an adjustable-rate mortgage (ARM) into a fixed-rate loan, and vice versa. Borrowers who refinance from an ARM take a fixed-rate mortgage to lock in a low rate. This helps them avoid higher payments over the life of the loan. Meanwhile, borrowers who shift from a fixed-rate to an ARM usually take advantage of the low introductory rate. This is viable during a normal economic climate when ARM introductory rates are lower than 30-year fixed mortgage. The low initial rate allows borrowers to shift their preference across to boost interest savings.
An ARM comes with a periodically changing rate which depends on market conditions. These come in hybrid terms such as 5/1, 7/1 and 10/1 ARMs. For example, if you take a 5/1 ARM, your interest rate will be fixed for the first five years. Afterwards, your rate will adjust once a year for the remaining term. When your rate increases, expect your monthly payment to get higher. But if market rates reset low, you can take advantage of low monthly payments. This is a viable financial option when rates remain within a low threshold.
However, ARMs become risky when market rates keep increasing every adjustment period. This can make your monthly payments unaffordable. If you can’t keep making payments, you might lose your home to foreclosure. To avoid this risk, many ARM borrowers eventually refinance into a fixed-rate loan. The predictable payments are also easier on your monthly budget. ARMs are also used by homebuyers who intend to move in a couple of years. They sell their home before the interest rate increases to avoid higher payments.
Removing MIP from Your FHA or USDA Loan
When you take a mortgage backed by the Federal Housing Authority (FHA) or the U.S. Department of Agriculture (USDA), be prepared to pay mortgage insurance premium (MIP). MIP is an added cost intended to protect the lender in case you default on your payments. This extra fee makes it possible for low to moderate income borrowers to obtain a mortgage if they do not qualify for conventional loans. It’s the compromise homebuyers make for the low down payment option and relaxed credit standards. MIP is paid both as an upfront fee and an annual fee for FHA and USDA loans.
FHA loans charge an upfront MIP fee of 1.75%, while the annual MIP fee is around 0.45% to 1.05% of the loan amount per year. MIP is required for the entire duration of the loan for 30-year FHA loans. On the other hand, it’s only paid for 11 years if you take a 15-year FHA mortgage.
For USDA loans, the upfront MIP fee is called a guarantee fee, which is 1% of your loan amount. Meanwhile, the annual guarantee fee is 0.35% of the loan’s value. Compared to FHA loans, you’ll notice MIP rates for USDA loans are lower. USDA MIP fees are typically paid for the entire life of the loan.
To remove the extra cost of MIP, some FHA and USDA loan borrowers refinance into a conventional mortgage. Since government-backed loans do not charge prepayment penalty, you can refinance as early as you need. However, note that you must build enough equity before you are eligible for refinancing.
FHA loan to conventional loan: To qualify for refinancing, your LTV ratio must be 80% or lower (20% home equity). After June 3, 2013, MIP can no longer be canceled unless you refinance into a conventional mortgage. But if your loan originated before June 3, 2013, you could still cancel MIP without refinancing given the following conditions:
- If you don’t have late payments and maintain a good payment record
- If your loan balance is 78% or below the FHA appraised value
- For 30-year FHA loans – it should be paid for at least 5 years
- For 15-year FHA loans – no need to follow the 5-year payment as long as balance is 78%
USDA loan to conventional loan: You can refinance into a conventional loan with 97% LTV (3% home equity). However, to steer clear of private mortgage insurance (PMI), your LTV ratio must be at least 80%. Make sure to avoid PMI to maximize your savings.
Upon refinancing, you’re entitled to mortgage interest deductions. Since you’re essentially taking out a new loan to pay off your original mortgage, you can continue deducting mortgage interest based on the amount you pay under the new loan. For cash-out refis, note that you can only qualify if you use your loan to construct or make improvements on your property.
Before the Tax Cuts and Jobs Act 2017, mortgage interest was deductible on the first $1 million of mortgage debt. But after December 15, 2017, the threshold has been reduced to the first $750,000 of mortgage debt, while those married and filing separately can deduct on the first $375,000 of their loan. The mortgage deduction limit is slated to change back to $1 million after 2025.
Accessing Home Equity
Cash-out refinancing is one way to tap home equity for major expenses. Many borrowers use it to fund home improvement projects such as expansion or renovation. But apart from cash-out refinances, there are other strategies to tap your home equity, such as taking a HELOC or home equity loan. These loan options are also called second mortgages.
A second mortgage is a loan you take out against a house that already has a mortgage. You use the equity in your home as collateral to borrow money. When you take a second mortgage, your lender takes a lien against a percentage of your home that you’ve paid off.
When it comes to mortgage payments, prepare to make a separate payment to another lender. While cash-out refis only require one monthly payment, taking a second mortgage entails making separate monthly payments to your first and second lender. This can be a challenge to track, so make sure you’re making timely payments.
Second mortgages such as HELOCs and home equity loans usually have higher rates than cash-out refis. When borrowers default on their mortgage, second lenders are only compensated after the original lender is paid. To hedge against this risk, second lenders impose higher rates. On the positive side, second mortgages come with more affordable closing costs compared to cash-out refis.
When to Consider a Second Mortgage
A second mortgage works if you need to borrow a large amount without replacing your current mortgage. Though this option entails paying a higher interest, you get to keep your existing mortgage term and rate. Next, you must be willing to make two separate mortgage payments each month for the rest of the term. Meanwhile, cash-out refinancing cannot guarantee you’ll obtain the same rate. Unless you’re keen on changing your rate, it doesn’t make sense to take a cash out refi, especially if you can’t obtain a lower rate.
Taking a second mortgage lets you decide how to draw money. If you’re thinking of taking money through a revolving line of credit, you can choose a HELOC. On the other hand, if you’ve decided on a definite amount, you can withdraw a one-time lump sum with a home equity loan. Majority of borrowers with second mortgages choose HELOCS, which account for around 90% of second mortgages.
Home Equity Line of Credit (HELOC)
HELOCs are the ideal option if you want to borrow money as needed. They function much like a credit card, providing you with a revolving credit line. This flexibility makes it appealing to borrowers, allowing them to cover extended expenses. You can withdraw up to a pre-approved limit while paying interest only on the amount you owe. But as a drawback, you may easily be tempted to keep taking money. That said, be careful not to withdraw over the limit.
HELOCs are structured with a draw period which usually lasts for the first 10 years. During the draw period, you can withdraw money as needed within the approved limit. Once the draw period ends, you are no longer allowed to take money. The remaining term is earmarked for paying back your lender.
HELOCs also come with adjustable interest rates, which means your monthly payments will change depending on the latest market conditions. The unpredictable payments can be hard to manage. You must prepare for higher monthly payments when interest rates rise. Likewise, you may have low monthly payments if interest rates adjust lower. HELOCs come with rate caps to keep your lifetime rate from increasing too high. But if you’re keeping a HELOC for 15 or 20 years, dealing with increasing payments can be a headache. Be prepared for this drawback when you take this option.
While HELOCs do not usually come with closing costs, some lenders may require $300 to $400 for home appraisals. Lenders also charge a $100 annual fee to keep you HELOC account in service.
Home Equity Loan
A home equity loan is given to borrowers as a one-time lump sum amount. It’s a practical option if you need funds for immediate or short-term expenses. For instance, you need $50,000 to do home improvements and repairs. This amount is given by the lender, then you pay it in monthly installments throughout your loan’s remaining term. Since home equity loans offer a one-time cash-out, you must estimate how much you need to borrow. If you need more funds, you can’t just draw money like with a HELOC. For this reason, home equity loans are not as appealing to borrowers.
On the other hand, home equity loans are structured with fixed mortgage rates. This guarantees you’ll make the same monthly principal and interest payments for the rest of the loan. It comes in different terms, including 5, 15, and 30 years terms. Even if market rates increase, you need not worry about expensive payments. You’ll be able to pay off your loan within the agreed term.
And compared to a HELOC, there’s no temptation to withdraw more money. If you want the convenience of stable payments, this option will work for you. Choose a home equity loan if you don’t need to borrow a very large amount over an extended period of time.
Closing costs for home equity loans are usually 2% to 5% based on your borrowed loan amount. This is significantly more affordable than refi closing costs. For instance, if you’re borrowing $35,000, your closing costs will be around $700 to $1,750.
Refinance to Merge Your First & Second Mortgage
Mortgage consolidation is the process of refinancing to combine your first and second mortgage. While not very common, you can consolidate your first and second mortgage when general market rates significantly fall. Mortgage consolidation is a good option for borrowers who want a more favorable rate and term for their original mortgage. While refinancing, your lender can roll in your second mortgage, resulting in one loan. With your mortgage merged as one, you no longer have to worry about making two separate payments. It simplifies your finances, making it easier to budget for one monthly payment.
As with all refinances, mortgage consolidation should only be done if you can obtain a lower rate. In this case, the interest rate must be lower than both your first and second mortgage. The lower rate will increase your interest savings throughout the term. If you can’t secure a lower rate, consolidating to a higher rate defeats the purpose of saving through consolidation. You’d be better off paying your first and second mortgage separately.
- Timing Mortgage Consolidation. You can refinance to combine your first and second mortgage immediately after opening your second mortgage. Generally, lenders let borrowers consolidate their mortgage if they have not withdrawn credit in the past 12 months. If you have a new HELOC and you won’t be withdrawing from it right away, you can apply for mortgage consolidation. If your HELOC is not new, avoiding withdrawals for 12 months lowers your LTV ratio by 20%.
- When You Need Higher Equity. Homeowners also consolidate their loans when their first and second mortgage balance goes beyond the conforming limits. In this case, lenders typically ask for at least 30% home equity, which is 70% LTV. But depending on your property and credit record, some lenders may ask for a higher LTV ratio. For an updated list of conforming loan limits, visit the Federal Housing Finance Agency website.
- Processing Time. Unlike regular refinancing, mortgage consolidation takes much longer to arrange and evaluate. Depending on your lender, some may have around 12 months waiting period right after your second mortgage is approved. Mortgage consolidation refinances also come with more detailed credit reviews which might extend your waiting time.
Why Homeowners Should Consolidate Their Mortgage
With the right circumstances, you can combine your first and second mortgage to obtain substantial savings. The following examples are good reasons to consolidate your home loans:
Change from an ARM to a Fixed-rate Mortgage
Most borrowers with second mortgages obtain a HELOC. Since HELOCs come with adjustable interest rates, borrowers typically deal with higher payments when rates increase. This can make your payments expensive when rates keep increasing over the remaining term. To secure a locked rate, you can consolidate your HELOC with your first mortgage into a fixed-rate loan.
For example, let’s suppose your monthly payment began at $300 with a credit line of $100,000. Over the years, when market rates rose, your monthly payment went as high as $700 after the draw period. However, if you consolidate your HELOC with your first mortgage at a lower rate, you can secure a fixed-rate loan with stable monthly payments.
Secure a Lower Interest Rate
Refinancing is only worthwhile if you secure a considerably lower rate. For this example, let’s suppose you got stuck with a high rate when you took your 30-year fixed mortgage 15 years ago. Back in January 2006, the average rate for a 30-year fixed mortgage was around 6.15% APR, based on Freddie Mac. But in January 28, 2021, the average 30-year fixed mortgage was 2.73% APR, according to the Federal Reserve. This is evidently much lower compared to 15 years ago. And if you refinance after 15 years, you’re basically sticking to the same schedule to pay off your mortgage. A 15-year fixed-rate refi also has an average rate of 2.41% APR in January 28, 2021.
Now let’s run the numbers. Using the above calculator, let’s determine how much your consolidated loan will cost. For example, your original mortgage has a remaining balance of $200,000 at 6.15% APR. Your second mortgage has a $35,000 balance at 8% APR. Your first mortgage has a monthly principal and interest payment of $1,800, while your second mortgage has a monthly payment of $800, for a combined payment of $2,600. Now, you’re refinancing both mortgages into a 15-year fixed-rate loan at 3.1% APR. Let’s review the results below.
First Mortgage Balance: $200,000
Monthly P&I Payment: $1,800
Rate of First Mortgage: 6.15% APR
Second Mortgage Balance: $35,000
Monthly P&I Payment: $800
Rate of Second Mortgage: 8% APR
Refinanced Rate: 3.1% APR
Refinanced Term: 15 years
Closing Cost: $6,000
|Mortgage Consolidation Refinance||Amount|
|New Monthly P&I payment||$1,634.19|
|Monthly Payment Change||decreased by $965.81|
|Months Before Interest Savings Offset Closing Costs||10 months|
|Remaining Interest Under Old Mortgages||$103,242.53|
|Total Interest Costs After Refinancing||$59,154.73|
|Interest Saved After Refinancing||$44,087.79|
This calculation did not include escrow costs. It also did not finance the closing costs.
Based on the results, if you consolidate your first mortgage at 6.15% APR with your second mortgage at 8% APR into a 15-year fixed mortgage at 3.1% APR, your monthly payment will decrease by $965.81.
If you keep your current mortgage, your total interest charges will amount to $103,242.53. However, if you consolidate your first and second mortgage, your total interest cost will only be $59,154.73. This will save you a total of $44,087.79 over the life of the loan.
But in order for this refinancing to yield any savings, you’ll need to stay in your current home for at least 10 months. This is your breakeven point, which is how long it will take for the monthly interest savings to offset refinancing’s closing costs. This example shows you’ll save a significant amount on interest charges while reducing your monthly payments if you consolidate your mortgage.
Pay Your Mortgage Faster
Paying off your mortgage early will save you tens and thousands of dollars on interest charges. It’s also one major debt off your list before you hit retirement. While taking a shorter term usually results in higher mortgage payments, securing a low enough rate can actually decrease your monthly payments.
In the following example, let’s presume you took a 30-year fixed mortgage that you’ve paid for 10 years. You’ve also taken a second mortgage which you need to pay in 20 years. If you refinance to merge your first and second mortgage, you can pay your loan early by 5 years. Review the example below.
First Mortgage Balance: $220,100
Monthly P&I Payment: $1,400
Rate of First Mortgage: 5.5% APR
Second Mortgage Balance: $35,000
Monthly P&I Payment: $700
Rate of Second Mortgage: 7.5% APR
Refinanced Rate: 3.1% APR
Refinanced Term: 15 years
Closing Cost: $6,000
|Mortgage Consolidation Refinance||Amount|
|New Monthly P&I payment||$1,773.97|
|Monthly Payment Change||decreased by $326.03|
|Months Before Interest Savings Offset Closing Costs||12 months|
|Remaining Interest Under Old Mortgages||$177,339.88|
|Total Interest Costs After Refinancing||$64,214.35|
|Interest Saved After Refinancing||$113,125.53|
This calculation did not include escrow costs. It also did not finance the closing costs.
In this example, if you refinance your first mortgage at 5.5% APR with your second mortgage at 7.5% APR into a 15-year fixed mortgage at 3.1% APR, your monthly payment will be lower by $326.03.
If you remain with your current mortgage, your total interest expenses will be $177,339.88. However, if you refinance to merge your first and second mortgage, your total interest costs will decrease to $64,214.35. This saves you $113,125.53 over the life of the loan. And since you took a 15-year fixed mortgage, you’ll be cutting 5 years off from your remaining 20-year term.
But in order for refinancing to earn any savings, you must stay in your current home for at least 12 months. This is your breakeven point, which is the time it takes to offset refinancing’s closing costs. This example shows you can reduce your term while lowering your monthly payments if you can obtain a low enough rate.
When to Avoid Mortgage Consolidation
While there are many advantages to merging your first and second mortgage, there are instances when this option is not a practical choice. When this happens, you’re better off remaining with your current loan. Consolidating your mortgage will result in higher costs than actual savings. If you answer yes to any of these questions, do not consolidate your mortgage:
Will my mortgage be paid off soon? It does not make sense to consolidate your mortgage if you only have 10 years or less on your term. This will unreasonably extend your mortgage. While you’ll have lower monthly payments, you’ll end up with much higher interest charges.
Does my mortgage have a lower rate than what I can get? The primary rule of refinancing is to obtain a lower rate. If you cannot secure a lower rate or at least match the existing rate on your first mortgage, consolidating will be a bad move. Refinancing to a higher interest rate will just increase your interest charges.
Will my refinanced mortgage require PMI? PMI is an added cost on conventional loans when your LTV ratio is higher than 80%. This means you do not have enough equity to refinance and consolidate your mortgage. To compensate for this insufficiency, lenders charge PMI. It’s best to avoid this extra cost. Wait a couple more months until you have a low enough LTV to steer clear of PMI.
Refinancing is a process that allows you to restructure your original mortgage and replace it with a more favorable rate and term. It’s essentially taking out a new mortgage that can help boost your savings. Besides rate and term refinances, you also have a cash-out option which lets you borrow against your home equity while changing your mortgage. The difference between your remaining mortgage balance and your new loan is the amount you receive from your lender.
To be eligible for refinancing, borrowers must have a credit score of at least 620. However, a higher credit score is recommended to secure a much lower rate. You should ideally have an LTV ratio of 80% or below to avoid private mortgage insurance when you refinance. Moreover, it entails expensive closing costs, which is around 3% to 6% of your loan amount. Since refinancing is a costly proposition, it should only be done if you can obtain a significantly lower rate and if you intend to remain long-term in your home.
Apart from cash-out refinancing, you can also tap home equity through a second mortgage such as a HELOC or home equity loan. HELOCs come as a revolving line of credit that gives you access to cash up to an approved limit. It also comes with an adjustable rate, which means your monthly payment can increase if market rates rise. You only have to pay interest on the amount you owe. Meanwhile, home equity loans are given as a one-time lump sum cash, which is ideal if you need a specific amount. It comes with a fixed-rate structure, which means your payments do not change. When you take a second mortgage, you make a separate payment to your first lender and your second lender.
If you obtain a second mortgage, you have the option to merge your first and second mortgage. This is called mortgage consolidation refinancing. When you choose this option, you must make sure to secure a rate that’s lower than your first or second mortgage. Lenders also allow you to consolidate your mortgage when you have not made HELOC withdrawals for at least 12 months. Do not consolidate your mortgage if it will be paid in 10 years or less. Doing so will extend your mortgage and leave you with higher interest charges.
In conclusion, refinancing is a viable strategy that can reduce your mortgage’s interest costs. When done right, it can maximize your savings and help pay your mortgage earlier.
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