Use refinancing to create other benefits

Although most people refinance to lower their monthly payments, as noted, you might refinance to achieve other cash management and wealth-building purposes, such as:

  • Equity buildup: As many as 50 percent of all refi borrowers select shorter-term loans. Lenders are originating record numbers of 10-, 15-, and 20-year mortgages. As Secret #15 reveals, shorter-term loans build equity much faster than the more common 30-year amortization period. After just 5 years of payments, a 15-year loan shows a lower balance than a 30-year loan shows after 10 years.
  • Pay off credit cards: Use lower-interest mortgage money to pay off higher interest credit cards and installment accounts. Execute this plan only if you possess enough self-discipline to stymie your high interest borrowing. Increasing numbers of people take out bill-payer refis. Then they run their credit card balances right back up to where they were before their refi. They've racked up more debt, and they've spent their equity. Such people help account for the growing number of property foreclosures.
  • Eliminate mortgage insurance: In some circumstances, the law permits you to cancel your PMI and stop paying those $50 to $150 a month premiums (see Secret #103). If your home has appreciated, or if you've created value through improvements, you can refi your balance at the new higher property value, which could drop your LTV below 80 percent. Thus there is no need for PMI.
  • Switch an ARM to a fixed-rate mortgage (FRM): If inflation appears to be heating up, you might go to the safety of a fixed-rate mortgage. Also, if you financed with a short-term horizon that now appears longer term, the FRM might prove the better choice, especially if FRM rates sit relatively low. As short-term ARM indexes jumped considerably during 2005-2007, hundreds of thousands of ARM borrowers switched to FRMs.
  • ARM to ARM: This strategy can work well when ARM rates are hitting lows. You can refi into another ARM with lower caps, a slower moving index, a slimmer margin, or more liberal terms of assumption. Even if your current payment doesn't decrease, you win if the new ARM includes more favorable features.
  • FRM to ARM: If you're just a few years away from selling a property, switch from an FRM to an ARM. Because you no longer need long-term interest rate protection, you save money with the ARM. If your new ARM includes a good assumption clause, this feature could enhance the sales appeal of your property. This tactic doesn't work in periods of flat or inverted yield curves—for example, 20062007. Also, you might hold onto a low interest, assumable fixed-rate mortgage if it still shows a high LTV.
  • Streamline refi: Mortgage Secrets reminds you that FHA and VA mortgages include a unique and desirable feature called streamlining. When rates fall, FHA/VA borrowers can refinance without an appraisal, credit check, income verification, or qualifying ratios. In the refi boom of the early- to mid-1990s, many Californians could not dump the high-rate mortgages they had originated in the 1980s because the value of their homes had temporarily dropped, or they were unemployed or underemployed and could not meet qualifying standards. Thanks to streamlining, no FHA/VA borrower faced that frustrating dilemma.
  • The good life: Although many homeowners squander their home equity on new cars, trucks, boats, jet skis, European vacations, and junior's college expenses, Mortgage Secrets cannot abide such frivolities. You cannot build the wealth you will need later if you eat your seed corn today. As to junior, tell him to pay college expenses with part-time (and summer time) job money. Please, no student loans. Debts from college are destroying the finances and wealth-building potential of millions of college grads—and dropouts. The student loan racket has now excited Congressional ire. Deceptive loan practices aren't limited to mortgages.

In addition to the previously mentioned benefits, a refinance can serve at least one more important purpose: It can generate funds for additional investment.

SECRET # 101

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