How do you decide when to refinance?

6 Replies

I bought my first house (owner occupied 3 family) last year and starting to wonder if I should refinance it since I bought it using an FHA loan with 3 percent down-payment. Per Zillow it is estimated to be worth an additional 100k right now. I also did some work to it so I know it's worth more. My current rate is 3.25 percent. How do you go about deciding when to refinance? When is it not worth it? Do you use a broker or pick the banks? Or any other useful tips I should know? Thanks in advance.

Originally posted by @Will Gaston :

@John Chace that seems like a great rate. What's your goal in refinancing? 

I would like to get rid of the PMI and eventually switch to a conventional loan instead of FHA. My rates are good right now but there are a lot of fees that come with FHA and trying to decide if the timing is right for the switch.

Also, potentially considering and cash-out refinance for a down-payment on another house (if that's allowed). 

I'd do it to get rid of the PMI. You might be able to get a rate in the 2's. After the refi you can use the extra funds for a DP

Originally posted by @Caleb Brown :

I'd do it to get rid of the PMI. You might be able to get a rate in the 2's. After the refi you can use the extra funds for a DP

Do you recommend going to a broker for the refi or go to different banks myself? Do banks ever pay for the closing cost?

First step is deciding the purpose of refinance. Are you trying to reduce payment, reduce term, reduce fees like removing PMI or get cash out?

Reducing payment can be accomplished three ways:

1. Lower interest rate.

2. Getting rid of PMI.

3. Extending the term back out to 30 years.

If you take cash out, it may actually increase your payment. That may be fine if the cash out has a useful purpose.

Some things to be aware of when refinancing:

1. New closing costs could be $3000 to $5000. You just paid these fees a year ago and you will be paying them again. They will be either up front or put into the loan which will increase payment or term. It may not be a problem, but closing costs are sunk fees. That means whether you hold the loan one year or 30 years, the fees are gone. I calculate how long it takes to break even on those fees. I refinanced a few properties in the last year and the payment savings allowed me to break even on fees within 24 months. Since I am holding longer than 24 months, it made sense.

2. The value isn't based on Zillow, but rather the appraisal value. You may think the property appreciated $100K in the last year, but you need comparable sales to support it. Improvements can help justify increase in value. Have a list of improvements you made, with cost ready to share with the appraiser. It is common for properties to not appraise for the expected value, so be prepared for that. The less time since purchasing, the harder it is to see larger appreciation without substantial rehab. This is even partly dependent on "luck of the draw" as far as which appraiser is sent to the job. 

3. It sounds like the property is owner occupied, which will give you preferred options for rates. If you expect to convert the property to a rental in the future, refinancing now may be a good idea.

4. Deductibility of interest follows use. You are only allowed to deduct interest against the property it is used to purchase. Say for example, you take out a new $250,000 loan and $50,000 is used to buy a new investment property. Only the interest on that $50,000 is deductible and it must be against the investment property. It is 50 of 250, so 20% of the interest can be deducted against the new purchase.