The decision whether to refinance your mortgage isn’t always an easy one, and your loan-to-value ratio can play a large part. The loan-to-value ratio, commonly referred to as LTV, refers to how much of your home’s value you are financing. While lenders generally like to see an 80-percent loan-to-value ratio, or lower, you may be able to qualify with a higher ratio by paying for mortgage insurance, according to Bankrate. Along with weighing LTV, it helps to consider interest rates, closing costs, prepayment penalties, and the total cost of the loan.
Paying Private Mortgage Insurance
If the equity in your home is less than 20 percent, the lender will charge you private mortgage insurance to refinance. You may already be paying for private mortgage insurance each month if you paid less than a 20-percent down payment when you bought the home. Although the premium is included in your monthly mortgage payment, the amount you pay depends on your credit and on the amount and type of your mortgage loan. Once your loan balance is paid down to 78 percent of your home’s original value, by law the lender must terminate the mortgage insurance, as long as you are current on your loan, notes Sara Millard, senior vice president and deputy general counsel at United Guaranty Corporation, in an article for Bankrate.
Including Closing Costs in the Equation
Mortgage refinance costs often include a variety of fees, such as an application fee, origination fees, a title search fee, and an appraisal fee. If you are refinancing to save money, additional fees can run into the thousands of dollars, but your lender may be willing to negotiate some of the costs. Without a lot of equity in your home, you may have to make a down payment or finance the closing costs out of pocket to keep the loan balance down. Refinancing may still be an option if taking out a new loan at a lower interest rate substantially lowers your monthly payment and the total amount of interest you pay over the life of the loan.
Considering Prepayment Penalties
If your mortgage documents contain a prepayment penalty clause, the penalty normally applies for a specified number of years. Prepayment penalties and the way lenders calculate them when you refinance a loan vary. Some lenders charge a percentage of the outstanding principal balance at the time you refinance. Another method of calculation is to charge you a certain number of months' worth of interest when you pay off the original loan, notes the Mortgage Professor. Depending on how much you still owe, a prepayment penalty could cost you several thousand dollars, in addition to the other closing costs. Lenders sometimes reduce the penalty by a declining percentage each year it applies.
Figuring Loan Break-Even Point
When refinance involves closing costs and a prepayment penalty, calculating the break-even point helps put the costs in perspective. A loan’s break-even point is the amount of time it takes you to recoup the costs of refinancing in terms of the savings you see in your monthly mortgage payments, says the Federal Reserve. For example, if you figure that it will take you three years to get back the costs of refinancing, but you intend to live in the house for at least five years, refinancing will save you money. If you know your job will require you to relocate before three years, you won't be living in the home for longer than it takes you to break even.
Amber Keefer has more than 25 years of experience working in the fields of human services and health care administration. Writing professionally since 1997, she has written articles covering business and finance, health, fitness, parenting and senior living issues for both print and online publications. Keefer holds a B.A. from Bloomsburg University of Pennsylvania and an M.B.A. in health care management from Baker College.