Refinance
Considerations
When you're making your decision, there
are several things to keep in mind.
First, even a small rate cut can pay off
quickly. That's because you can easily find mortgage companies willing
to waive routine refinancing charges such as application, appraisal and
legal fees (which can add up to $1,500 to $3,000). Of course, in
exchange for low or no up-front costs, you'll have to be willing to
accept a rate that's somewhat higher than the prevailing rock bottom.
Second, if you are planning to stay in
your home for at least three to five years, it may make sense to pay
"points" (a point equals 1% of the loan amount) and closing
costs to get the lowest available rate.
And third, you can avoid laying out cash
and still get a low rate by adding the points and closing costs to your
new mortgage. Does that mean shouldering a lot of extra debt? Not
necessarily. If you've had your current mortgage for at least three
years, you've probably reduced your balance by several thousand dollars.
So you may be able to tack your closing costs onto your new loan and
still end up with a mortgage that's smaller than your original one --
plus, of course, a lower rate and lower monthly payment.
Refinance
Once, Then Do It Again
When rates fall steadily, refinancing may
make sense even if you have done so once already. Bob and Marsha Bush of
Aurora, Illinois, refinanced twice within three months in 1998. In
October, they trimmed the rate on their 30-year fixed mortgage by a full
point -- from 9.13% to 8.13% -- for a monthly savings of $63. Plus,
because home prices in their area had boosted their home equity, they
were able to stop paying private mortgage insurance that cost them $120
a month.
To exploit continued decline in rates,
the Bush's refinanced again in December. Their new 30-year fixed
mortgage is at 7.375%, lopping another $55 off their monthly bill. Since
the couple had chosen a no-cost refinancing each time, their total
out-of-pocket expenses came to just $400 in appraisal fees. So by the
time you read this, they will already have recouped their up front
costs. "Now we can use the savings to build up a cash emergency
fund," says Bob.
If you are considering a second
refinancing, don't overlook this potential tax write-off: When you pay
points to refinance, you must deduct the amount over the life of the
loan, usually 30 years. But when you refinance a second time, all of the
points that have not yet been deducted from the first refinancing can be
written off in a lump sum. Say you refinanced to a 30-year mortgage in
1993 and paid $3,000 in points. By now, you would have written off
roughly $500. If you refinance again this year, you could deduct the
remaining $2,500 on your 1998 tax return. For a homeowner in the 28% tax
bracket, that works out to a savings of $700 -- enough to offset some or
all of your costs this time around.
Many borrowers use a refinance to shorten
the term of the mortgage. And brace yourself: Even at low rates, a
shorter term means a higher monthly payment. The benefit is that you'll
build up equity faster and pay far less in total interest over the life
of the loan.
Consider Jim Neill, 48, a real estate
broker and his wife Merrilyn, 55, a psychotherapist. Recently, the
couple took out a 15-year fixed-rate loan at 6.75% to replace an 8.13%
ARM with a 30-year term. Their monthly payment jumped by $200, but now
they will own their own home outright by the time they retire. In
addition, the total interest on the 15-year loan will come to $95,447,
vs. $222,234 on the remaining life of the ARM -- and that assumes their
adjustable rate would have held steady at its current 8.13%. "This
is forced savings," says Jim. "When we retire, we can scale
down and take equity out of the house."
If you can't afford the payments on a
15-year mortgage, your next best means of building equity is to
refinance for less than 30 years. To do so, ask your mortgage company to
customize your new loan's term to match the years that are left on your
old loan -- if you are five years into a 30-year mortgage, for example,
ask for a 25-year loan.
Trade
your ARM For A Fixed Rate
By switching to a fixed-rate loan, you
will not only reduce your payment, you will also likely lock in an
attractive rate for as long as you own your home.
In fact, while one-year ARMs currently
offer tempting introductory rates averaging 5.59%, most experts
recommend avoiding them, because you could easily find yourself facing
sharply higher payments in the near future, even if interest rates don't
rise. Why? Well, after the introductory rate expires, ARMs are typically
pegged to the one-year Treasury rate (recently 5.25%) plus 2.75
percentage points, with increases of as much as two points a year.
Assuming interest rates don't change, you would pay 7.59% in the second
year (the full two-point increase) and 8% in the third year.
There are certain cases, however, where
an ARM makes sense. If you are fairly certain you'll be moving within
five years, you can save some money -- and avoid rising payments -- with
a five-year ARM, recently averaging 6.62%. Such loans offer a fixed rate
for five years and adjust annually thereafter.
Refinance
Costs
When you refinance your mortgage, you
usually pay off your original mortgage and sign a new loan. With a new
loan, you again pay most of the same costs you paid to get your original
mortgage. These can include settlement costs, discount points, and other
fees. You also may be charged a penalty for paying off your original
loan early, although some states prohibit this. The total expense for
refinancing a mortgage depends on the interest rate, number of points,
and other costs required to obtain a loan. To obtain the lowest rate
offered, most mortgage companies will charge several points, and the
total cost can run between three and six percent of the total amount you
borrow. So, for example, on a $100,000 mortgage, the company might
charge you between $3,000 and $6,000. However, some companies may offer
zero points at a higher interest rate, which may significantly reduce
your initial costs, although your payments may be somewhat higher.
Analyze
Your Savings
Check the market closely to determine the
available rates and the costs associated with refinancing. These costs
can include items such as an appraisal and other various fees and
points. Then determine what your new payment would be if you refinanced.
You can estimate how long it will take to recover the costs of
refinancing by dividing your closing costs by the difference between
your new and old payments (your monthly savings). However, the ultimate
amount you may save depends on many factors, including your total
refinancing costs, whether you sell your home in the near future, and
the effects of refinancing on your taxes. The old rule of thumb used to
be that you shouldn't refinance unless the new interest rate is at least
two percentage points lower. However, many companies are now offering
zero point loans and low-cost refinancing. Therefore, even if your rate
change is less than one percentage point, you may be able to save some
money by refinancing.
Paying
Points For A Lower Rate
In refinancing, a mortgage company
usually offers a range of interest rates at different amounts of points.
A point equals one percent of the loan amount. For example, three points
on a $100,000 mortgage loan would add $3,000 to the refinancing charges.
Analyzing various interest rates and
associated points may save you money. As a rule of thumb, each point
adds about one-eighth to one-quarter of one percent to the interest rate
the mortgage company is offering.
Generally, the lower the interest rate on
the loan, the more points the lending institution will charge. Some
companies offer refinancing with no points, but generally charge higher
interest rates.
To decide what combination of rate and
points is best for you, balance the amount you can pay up front with the
amount you can pay monthly. The less time that you keep the loan, the
more expensive points become. If you plan to stay in your house for a
long time, then it may be worthwhile to pay additional points to obtain
a lower interest rate.
Some companies may offer to finance the
points so that you do not have to pay them up front. This means that the
points will be added to your loan balance, and you will pay a finance
charge on them. Although this may enable you to get the financing, it
also will increase the amount of your monthly payments.
Consider
A Different Mortgage Program When Refinancing
If you are thinking about refinancing
your mortgage, you might want to consider other types of mortgages. For
example, you might want to look into a 15-year, fixed-rate mortgage. In
this plan, your mortgage payments are somewhat higher than a longer-term
loan, but you pay substantially less interest over the life of the loan
and build equity more quickly. (Of course, this also means you have less
interest to deduct on your income tax return.)
You also might want to consider
refinancing if you have an adjustable rate mortgage with high or no
limits on interest rate increases. You might want to switch to a
fixed-rate mortgage or to an adjustable rate mortgage that limits
changes in the rate at each adjustment date as well as over the life of
the loan.
If you decide to apply for refinancing
with a particular mortgage company, and if you do not want to let the
interest rate "float" until closing, get a written statement
to guarantee the interest rate and the number of discount points that
you will pay at closing. This binding commitment or "lock-in"
ensures that the mortgage company will not raise these costs even if
rates increase before you settle on the new loan.
Most companies place a limit on the
length of time (say, 60 days) they will guarantee the interest rate. You
must sign the loan during that time or lose the benefit of that
particular rate. Because many people refinance their mortgages when
rates decline, there may be a delay in processing the papers. Therefore,
you may want to contact the company periodically to check on the
progress of your loan approval and to see if additional information is
needed. |
