Changes in the interest rate environment and changes in financial circumstances have made refinancing a fact of life for the active real estate investor. Individual homeowners may be able to stick their head in the sand and steadfastly pay off a 30 year fully amortized mortgage. Real estate investors on the other hand need to keep an eye out for the opportunity to tweak their financial situation. This includes willingness to go through the paperwork of a refinance.
It is important to be clear on this point. Refinancing a mortgage requires time and effort. Regulations that were put in place as a result of the mortgage meltdown of 2008 put a burden on lenders and borrowers alike. In light of this, a successful refinance is one that puts the borrower in a better financial position while considering the cost of the process itself.
Importance of Bookkeeping and a Good Credit Score
Like the warning label on a box containing a child’s toy, loan applications have a warning label. The need to provide factual data regarding a personal financial situation along with the corresponding documentation proving those assertions can be intimidating for the sloppy bookkeeper. But there is simply no way around it. Financial hygiene requires good bookkeeping. Completing a mortgage application is a test of this skill.
Of course, the earlier this skill is developed the better. Good bookkeeping includes managing household cash flow, which typically results in a good credit score. This is one element in the refinancing process that cannot be pulled out of a file cabinet. It must be developed over time. In fact, a credit score that has been increased due to prudent financial management can be one reason to refinance a mortgage on more favorable terms.
How to Refinance a Mortgage on Better Terms
“More favorable terms” is sometimes difficult to define. It can vary based on the financial needs of the borrower. For someone who wants to increase the amount of their mortgage in order to invest the equity in a different property, “better” does not mean a lower monthly payment. The same is true for someone who shortens the term of their mortgage from 30 to 15 years with the goal of being debt-free in retirement. A workable definition of better means that the refinance satisfies the financial motivation for the refinance.
But sometimes defining better is even more complicated than that. The example in the previous paragraph of shortening a mortgage term from 30 to 15 years might not be the best way to eliminate mortgage debt by retirement. Creating a side fund with the difference in payments might be a more effective strategy. This strategy depends on the rate of interest that can be earned and the diligence of saving the difference. The same can be said for deciding if it is beneficial to pay for a lower interest rate.
This last question involves a financial calculation known as the time value of money. The formulas involved are sophisticated, but use interest rates, dollar amounts and periods of time to equate a dollar today with a dollar in the future. Online financial calculators are available along with useful examples to explain key concepts. Often times though, deciding which interest rate to use in the calculation is the hardest part.
More Perks of a Successful Refinance
Setting aside technical questions, achieving a successful refinance also means entering a financial relationship with a lender. Sometimes a successful refinance means the real estate borrower has begun building an important business relationship with a new source of operating capital, such as a hard money lender. The ability to return to that lender in the future may, in and of itself, be considered important and a key measure of success.