Refinance Checklist: What Are Your Goals?

2020: What a year of highs and lows! High anxiety, high unemployment, lower income for many people, but also lower interest rates for borrowers. Homeowners who had been biding their time waiting for interest rates to drop so they could refinance their mortgage couldn't have expected rates to fall as low as they did in 2020. People everywhere seized the opportunity to lower their house payment.

Demand grew so high that it triggered the feds to apply the Adverse Market Refinance Fee, which we've written about earlier. In short, it's a 0.5% fee charged to refi loans sold to Fannie Mae or Freddie Mac. That means the fee applies to about two-thirds of all refinances. Both standard and cash-out refinance loans are subject to the fee (it doesn't apply to homebuying).

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Meeting the high demand has been a challenge for lenders who, in the coronavirus pandemic, were staffing their offices with fewer representatives. By now, though, banks have adjusted to staggered shifts and employees working from home. They are better able to meet the incredible demand for mortgage refinancing.

How high is the demand? According to the Mortgage Bankers Association this week, refinance activity increased 89% in December 2020 compared to the same week a year before.

So that you can prepare yourself for the mortgage refinance experience we thought we'd put together a checklist. Your goals are the first category.

What Are Your Goals?

Taking advantage of record-low interest rates is certainly a key driver of demand in refinancing, but it isn't the only reason people refinance their home. Some hope to shorten the term of their loan so they will own the home sooner. Others want to fund home projects and thus build (or at least preserve) their equity. Still others are facing reduced income in the pandemic and want to refinance in order to keep their home.

"I want to lower my payment."

In the example we bring you here, a drop of just 1% in a 30-year mortgage can save the homeowner $135 every month and a whopping $49,000 in total. Look at this comparison of a $250,000 loan balance. The only variable is the interest rate.

Different Interest Paid Over 30 Years
LOAN	INTEREST	MO. PYMT	TOTAL INTEREST
$250,000	3.59%	$1,135	$158,675
$250,000	2.59%	$1,000	$109,834

For the purposes of this comparison, we've left out property taxes, homeowner's insurance to cover yourself, and any mortgage insurance (PMI) you might also be required to pay to cover the lender's risk. We wanted to show you the naked overall savings you can get when the interest rate drops just 1%, which, as you can see, are substantial.

"I want to shorten the loan term."

The most popular mortgage in America is the 30-year fixed-rate, therefore most buyers face a long road of debt when they sign on. Going back to the starting point by refinancing another 30-year loan isn't appealing to many people. Some use refinancing as the opportunity to shorten their term whether or not their monthly payment changes much.

When you've already paid six or seven years on a mortgage (in other words, you have 23-24 years left), refinancing at a lower interest rate but only for 20 years can save you a lot of money. Your monthly payments might not change much, but you'll own the home years sooner than you initially expected and, come that day, will have paid a lot less interest.

It's great when a refinance brings you years closer to full homeownership. Just ask your lender to amortize your refinance loan for 25, 23, 20, or some other number of years. They will adjust your payments accordingly.

Certain home improvement projects can pay for themselves in equity and are therefore a great use of a cash-out refinance.

"I want to get cash out of the house to make repairs and improvements."

Since a refinance replaces an existing home loan with another, there's an opportunity to increase your loan balance and take the difference in cash. For example, if you owe $150,000 on your home, you could swap that loan for a new one at $175,000 and "cash out" $25,000.

Lenders are happy to go along with a cash-out refi when the home's value has appreciated. Your home is worth more now, so even though you are increasing your debt, the ratio debt-to-value stays about the same. Also, since you've already made years of payments, you own more of the home now (equity) and are a more attractive, dependable borrower in the eyes of the bank.

Speaking of equity, a great use of cash-out refi money is to maintain the property. Use the funds for a new roof, say, or to reseal the driveway. Preserving your home's value with regular maintenance doesn't just make it a more comfortable place to live; it preserves your investment.

Certain home improvement projects can pay for themselves in equity and are therefore a great use of a cash-out refinance. People dream of posh swimming pools and gourmet kitchens, but the most financially rewarding project turns out to be attic insulation, according to a survey by Remodeling magazine, which Realtor.com wrote about. For every $100 spent on attic insulation, you can expect to recoup $116.90 when you sell the home.

Next Up: Closing Costs and Other Financial Concerns

Keep in mind that refinancing involves closing costs. It literally costs money to save money. However, some closing costs are negotiable. The need to pay closing costs is why some refinance plans don't make financial sense in the end. That will be the next topic in our refinance checklist, so please stay tuned.