Refinance Your Mortgage?

Let’s suppose you own a home that you bought several years ago when rates were higher than they are today. You have heard mortgage company advertisements for refinancing. But this whole refinance thing sounds confusing. Yet, you have a sick feeling in the pit of your stomach that with every monthly payment, you are spending more than you should. So, what to do? Follow the line of least resistance, or look into this refinancing thing?

Despite the confusion I run into as I present the No Debt No Sweat! Christian Money Management Seminar at churches around the country, there really isn’t anything conceptually complicated about refinancing your home. Granted, you might want to contact your tax advisor since the IRS may treat some of your refinancing expenses differently for tax purposes. This, however, is usually not a major issue for most people. The main difference in the original purchase mortgage you made on your house and a refinance is that with the first loan you were moving into a new home, and with the second, you’re going to stay put. That’s right, this time there won’t be any long good-byes or moving vans involved.

It’s possible that a lot has changed since you first bought your home. You may find that it’s much quicker and easier today to get a home loan than it was several years ago. Also, think about the savings. What if I told you that this simple exercise could put an extra $2,500 (pre-tax) a year into your pocket — then, would you be interested? Well, it may.

Look at this hypothetical example: Suppose, at present, you have a $150,000 mortgage loan at 8 and 3/4% with a monthly payment (principal and interest only) of about $1,180. By refinancing it at 2% less (6 and 3/4 %) your monthly payments might drop by over $200 per month to around $973. That’s almost $2,500 a year in savings.

Obviously, this is just an illustration. Refinancing your loan can be a time consuming and expensive process. There are often a number of costs involved like origination fees, title insurance, appraisal fees, tax implications, etc. All of these things will have an effect on whether a refinance is appropriate for you. Also, it is wise to review your present mortgage agreement for prepayment penalty clauses before you go too far in the process. Mortgage experts say it all boils down to this: Do you plan to keep the home long enough to recapture the expenses involved in getting a new mortgage? You can determine this by figuring how much you will be saving each month at the new rate, then divide the refinancing and other costs by that monthly savings to see how many months it will take to recapture those expenses.

For instance, suppose your new monthly payment is $300 less than the old one, and that the refinance expenses total $4,500. First, since the $300 is a pre-tax figure, you will want to know what the “true” net savings are. If, for instance, you are in the 31% tax bracket, your monthly savings may net down to $207 ($300x.69=$207). Then, divide the $4,500 of refinance costs by the $207 your saving each month, and you will see that it may take about 22 months for you to break even.

If It’s Too Good To Be True…

Remember, it’s a competitive world out there. Because of competition many lenders will reduce, or even waive some of the fees. Don’t be afraid to ask. But, on the other hand, beware of deals that look too good to be true — they very well may be. For instance, don’t be fooled into buying a mortgage just because they promise fewer closing points. (Often, as a one-time rate enhancer, a lender charges points on a loan at closing. One point is equal to 1% of the principal amount of the loan.) For instance, suppose you were talking with two lenders about a 15 year, $200,000 mortgage. Lender A offers you the loan at 7 and 1/2% with 3 points (or, $6,000). Lender B pitches you the same $200,000 mortgage at 8% with only 21/2 points (or, $5,000). Which is the better deal?

Well, it’s really pretty simple. Here’s how to figure it: Begin by comparing the monthly payments on the principal and interest of each loan. You’ll see that Lender A’s 7 1/2% loan will carry monthly payments of about $1,854, and that Lender B’s 8% mortgage will cost about $1,911 monthly. That’s a difference of $57 per month. Now, by dividing that $57 (of monthly payment difference) into the $1,000 (of extra point cost from Lender A), you see that in about 18 months the cost of the extra half point from Lender A is recaptured. So, this means if you are planning to stay in the house for much more than 18 months, it may make better sense to pay the extra half point to Lender A and take the 7 1/2% loan. Of course, other costs and tax implications may affect the numbers somewhat, but the general principal holds.

Three Reasons To Consider Refinancing

Experts in the field frequently mention the following three reasons to consider a refinance. Personally, I consider only the first two reasons to be valid. In my opinion, the third reason is almost always a mistake.

1) To cut your monthly costs. Home mortgage rates fluctuate tremendously. When I came into the real estate business in the mid-70’s rates ranged from the high 8% range to over 9%. Since then, the numbers have been all over the board. In the early 1980’s rates went over 15%. At this writing, some are under 6%. A wise homeowner pays attention to rates, and when the time is right — he springs into action. As the earlier illustration shows, sometimes a refi can save a family tens of thousands of dollars in interest over the life of the loan.

2) To improve the terms or conditions of your present loan. Some people find themselves stuck with an adjustable rate mortgage (ARM) that begins to escalate shortly after they move into their home. As I have already said, I don’t think this is generally the best way to buy a home. Often, the only way out of such a loan is with a new fixed rate mortgage. Also, some people get into a short-term mortgage that has a huge balloon payment due. More often than not, they have a tough time paying the full amount when it comes due, and refinancing their mortgage can make sense.

3) To get money out of the equity in your home. Personally, I believe this the worst reason to refinance a home. However, some people can’t resist the pitch to refinance their homes with larger mortgages that allow them to take “spending cash” away from the closing. Please don’t do this! Why jeopardize your family’s security and your own peace of mind by going deeper in debt on your home to buy a new car or stereo? Your goal should be to pay your home off as quickly as possible — not to go deeper in the hole

What About the “2% Rule”?

Some people in the field suggest that the time to refinance is whenever loan rates have dropped by 1 and 1/2% to 2%, or more. While this is probably not a bad generalization, it doesn’t hold in every situation. There are times when rates have dropped by 2%, or even more, and it still may be unwise to refinance. Such could be the case if the lender’s costs and other expenses are excessively high, or if you are planning to move in the near future before you can recoup the refi expenses.

Conversely, there are times when refinancing can serve a homeowner well even when rates are down by less than 2%. Frequently, a homeowner can enjoy real savings with even a lesser rate reduction if he watches his expenses and doesn’t plan to move in the near future.

Five Considerations About Refinancing Your Home

According to my friend Mike Hardwick with Churchill Mortgage Corporation, there are 5 things to consider before you refinance your home:

1) How much will the new mortgage reduce your interest rate?

2) How much will your monthly payment be reduced?

3) Check to see if there are any prepayment penalties on your present mortgage.

4) What will the expenses be for things like closing costs, points, loan origination fees, application charges, appraisals, inspections, title insurance, mortgage insurance, etc? (I would also add possible tax implications to this list.)

5) How many years do you plan to stay in this home?

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