Mortgage Refinance

This isn't going to be a fancy project post... since we have just scratched the surface on getting started with our reno.  But I wanted to go over a little of the process of refinancing our house to help demystify the process of using home equity.  There are a lot of reasons to refinance!  I our first refinance we used our equity to consolidate a couple of our loans (add the balance of multiple loans into a single loan) and use the remaining cash to renovate our kitchen.  This time, we are using the entire sum for renovating, and we are lowering our interest rate as well. 

*Quick Disclosure: I'm not an accountant, real estate agent, or mortgage underwriter.  So, I'm really writing from my own experience.  Your own financial needs and planning will vary!  Don't be afraid to ask questions from your own financial institutions. 

​Mortgage Finance 101

​Every loan has three components: security, the interest rate, and the term.  For a mortgage, the security is in a secured loan: the house is collateral and the lender can take possession of the property if the loan goes unpaid.  Unsecured debt would be things like a personal loan or a credit card.  The interest rate is the lender's ongoing charge for the use of their money.  Rates can either be fixed or adjustable.  We are using a fixed-rate that is set by the current market, and will not be adjusted over time.  The term of our loan is 30-years: the amount of time we will pay if we only make minimum payments. 

Looking more at the interest component on any mortgage, it's good to note the amortization schedule.  This is how lenders balance when interest is paid on a loan.  In a fixed-rate mortgage, the interest is paid more on the front-end of the loan instead of evenly across the life of the loan.  Looking at the example, since interest is much higher than the principal it is early in the life of the loan.  The only real way to get around that is to make additional payments on the principal each month: the more principal is paid off, the less interest that accrues. Even just rounding up from $65 to $70 or $100 every month can save a lot in the long run. ​

The other part of the example shows a monthly escrow payment: these are used when the mortgage company manages payments to homeowners insurance and/or property taxes.  This account adds the cost of both together, spreads that cost over the year, and divides the payments into the monthly mortgage payment.  Each year, the escrow payment gets adjusted based on the amount in the account, property tax increases, and homeowner's insurance costs.  So, in a growing real estate market where property taxes are expected to increase, adding additional funds to the escrow account can help to keep the payment low for the following year.  It is also the easiest way to pay homeowner's insurance if switching coverage. 

​Interest Rate Nuances

​Interest rates are largely determined by the current economic and real estate markets; as the market improves, interest rates generally increase and as the market recedes, interest rates generally decrease. One option for borrowers to avoid some of that market volatility is to lock the interest rate.  In the US, once credit is pulled and an interest rate secured, borrowers can decide if they want to use the current rate or continue to play the market.  Since rates are currently rising, we chose to lock ours.  

We are also spending points to lower our interest rate further.  Since we are in a good position with our house and do not plan to move any time in the near future, it makes financial sense for us to buy points on our new mortgage.  What that means, is we are paying a few thousand dollars up front (not rolled into our closing costs, which can be added to the mortgage total) to lower our interest rate. How much it costs to lower each point (.25%, generally) varies by lender.  It's basically a way to pay a little bit of interest up front to pay less over time.  It's a long-term savings strategy that makes sense if you plan to be in your home for a long time, as it usually takes 3-4 years for the point-buy-down to be a financial gain.

​What We Needed to Close

​As always, there is documentation needed to write a mortgage.  We are working with our local credit union, and they have made the process very straight forward. So, we've only needed a few documents on hand:
1) 2020 and 2021 W-2s
2) Last Two Pay Stubs
3) Current Mortgage Statement
4) Homeowner's Insurance

The last item we needed is the appraisal.  This is an independent evaluation of the home's monetary value.  Refinance appraisals are a little unique, since these are not subject to market volatility in the same way as a sales appraisal can be.  Our appraiser asked us about the changes we've made to our house since we purchased and a little about our systems. He measured the exterior of our house, and got a sense of all our livable spaces.  We should get the final numbers back some time next week, then it's go time!