If you're dazzled by new low interest rates and dream of reducing your monthly mortgage payments, if you foresee a major expense, or if you simply want to pay down credit card debts with a better interest rate, you might just get what you wish for. In matters of real estate, there's rarely a quick and easy formula for all, but the profiles below will help you pinpoint your refinancing options.

Some of the primary reasons for refinancing are to lower monthly payments, pay off a loan or build equity faster, convert an adjustable rate mortgage (ARM) into a fixed-rate mortgage, or change other loan terms.

If you can refinance today with a "no-cost" loan at a lower interest rate�meaning you pay no points or closing costs, and the interest rate is actually lower than your current rate�run, don't walk, to your lender's office. But this golden scenario rarely applies. As a next step, ask yourself these three questions, and see why they're so important.
 

Potential disadvantages of refinancing

Finally, even if refinancing isn't a good choice today, your lender may be willing to make changes to your current loan to adapt to your needs.

For homeowners who need a lump sum of money or a revolving credit line to pay for a specific cost such as college tuition, medical expenses, or reducing non-deductible credit card debt, home equity options make more sense than refinancing. Owners who have built up equity through a first-mortgage down payment, paying down some principal, or an increase in property values can borrow against that equity.

Home equity options are usually based on a given percentage of your home's appraised value, minus your remaining mortgage balance. For example, if your home is appraised at $150,000, then 80 percent of that total would be $120,000. If your remaining unpaid mortgage is $80,000, the result would be $40,000 of available equity. (Note: Many banks now offer lines of credit at 90 or even 100 percent of your home's loan-to-value ratio.) As with a mortgage loan, the actual loan amount may vary depending on your credit history, outstanding debts, income, and the like.

Interest rates are variable, usually one to three points above prime�and because your house stands as collateral, interest is also tax-deductible. That's the good news. The downside is that because your house is used as security, you could lose it if you fall behind on payments. Home equity options include:

Home equity loan

These are traditional fixed-rate loans that work well if you need a lump sum of cash�say, to start a business, pay college tuition or medical expenses, or consolidate credit card debt. Home equity loans are similar to second mortgages in that payments are usually made monthly over 10 to 30 years, resulting in full repayment by the end of the loan.

If you choose a variable-rate equity loan, your lender must give you an example of minimum monthly payments and maximum interest for the particular amount you would borrow. Fees often apply, including points, application fees, appraisal, and credit check. However, if you pay more points up front to borrow at a 100 percent loan-to-value (LTV) ratio, all or some of these charges may be waived.

The annual percentage rate (APR) for a home equity loan takes points, fees, and interest rate into account. Be sure to ask your lender for a chart of the loan's APR, and discuss whether an equity second mortgage makes more sense than refinancing with a new first mortgage.

 

Home equity line of credit

Home equity lines of credit are more flexible and usually carry a shorter term than home equity loans. This is a good option for homeowners who have occasional or irregular needs for extra cash, such as car payments or even protecting against overdraft fees on a checking account. With an equity credit line, you receive a specific credit limit based on a percentage of your home's appraised value (usually 75%) minus your remaining mortgage balance. Your ability to repay is also taken into account. One advantage of this option is that you pay interest only on the amount you use, so you don't run up interest charges for unused portions, and using nothing costs you nothing.

Agreements are often divided into a draw period and a payback period. During the draw period, commonly five to ten years, you can withdraw any portion of the funds at any time by writing checks against the credit line. Payments revolve back into your credit line as available funds. In some cases you might make payments on interest only until the loan comes due. When the draw period ends, you may be allowed to renew the line of credit, or your full outstanding balance might be due in one payment. Minimum withdrawal amounts or monthly payments may apply, as well as other limitations, all of which will be spelled out in your agreement.

The APR for equity credit lines is calculated differently than for equity loans�points and other fees aren't rolled into the APR, only the periodic interest rate is�so be careful when making cost comparisons. Because a variety of credit-line plans are available with different terms, costs, and APRs, discuss the options with your lender.

Potential disadvantages of borrowing on equity:

Second mortgages�subordinate liens over a first mortgage�are most often used to raise cash for refinancing or to bulk up a down payment on a first house at the time of purchase. They're usually calculated at 75 to 80 percent of the home's appraised value and carry a shorter 15-year term with fixed monthly payments. You can generally close on a second mortgage within two or three weeks of applying.

Because they create more risk for lenders, conditions for qualifying are stricter and interest rates higher than for adjustable-rate home equity loans, conventional ARMs, or fixed-rate first mortgages, but over time they're less costly than refinancing. Separate closing costs usually apply.