Archive for Monday, December 3, 2001

Experts offer advice for refinancing

December 3, 2001


On the surface, it's a no-brainer.

Mortgage rates are at record lows, so it's a great time to refinance your mortgage and cut your monthly payment.

Many homeowners already have jumped on the bandwagon.

The rate at which consumers applied for mortgage refinancings has increased more than threefold since August, according to the Mortgage Bankers Association of America.

Lender Craig Jarrell said he'd literally been fielding one refinancing call after another.

While it may seem logical to refinance your mortgage in the current low-interest-rate environment, it's not for everyone, experts say. And there are many factors to consider before deciding whether it's worth refinancing.

The first thing to remember is that when you refinance your house, you're taking out a new mortgage, so you'll have to undergo the same process you did when you took out your first mortgage.

This means you'll have to get an appraisal and a credit check.

And "you will have to research the lender to find the suitable candidate to write you a new loan," said Keith Gumbinger, a mortgage analyst at HSH Associates in Butler, N.J., the largest publisher of mortgage information. "You're going to do some research, assemble your credit reports the whole nine yards."

You might get a break on that if you approach your current lender for refinancing. "They might be able to offer you streamlined refinancing, which could save some time, some research, certainly some costs," Gumbinger said.

But the ultimate issue you have to settle is whether refinancing your mortgage will be worth it, given the costs in time and money you'd have to pay.

Interest rate

Traditionally, the rule of thumb has been that you should get at least a 2 percentage-point drop in your current interest rate to make it worthwhile. That rule isn't so hard and fast today.

"The 2-percentage rule no longer applies," said Brian Nottage, an economist at Inc. in West Chester, Pa., an economic research firm. "The upfront costs are just so much smaller."

That's partly because hot competition has pushed down the average fees and points today on a 30-year fixed-rate mortgage to 1.24 percent of the total value of the loan, from an average 2.33 percent in 1990, he said.

"It means that you need a much smaller decrease in the interest rate to make it worthwhile," Nottage said.

In fact, Jarrell's firm has chopped the 2-percentage-point rule down to 1.5 percentage points.

"In today's interest environment, a 1.5-percentage drop in your rate is sufficient to get a good refinance," said Jarrell, a member of the board of directors of the Texas Association of Mortgage Bankers.

A key factor in a mortgage refinance is determining how long you plan to remain in your home, because you have to stay long enough to recoup your closing costs.

Breakeven point

So how long would that be? To find out, you have to determine your breakeven point, which is the point where the savings each month has offset the cost to refinance.

To calculate your breakeven point, first figure out the difference between your current mortgage payment and your payment under a refinance your savings. Then divide your closing costs by that number.

For example, say you wanted to refinance a $100,000, 30-year loan carrying a 7.5 percent rate with a monthly payment of $699.21. You're refinancing to a 6.5 percent rate, with closing costs of $2,000. Your monthly payment would drop to $632.06, a savings of $67.15.

Using the formula, your breakeven point would be 30 months ($2,000 divided by $67.15 equals 28.78 months).

"That's the point where you have recouped your out-of-pocket expenses and are beginning to save on the refinance," Gumbinger said. "In this case, in the 31st month, you will actually save $67.15 a month.

"Every month you stay (in your home) past the breakeven point, your savings begin to accumulate."

Closing costs

There are several ways to handle closing costs.

Closing costs are expenses incurred by buyers and sellers in transferring ownership of a property. Closing costs normally include an origination fee, an attorney's fee, taxes, escrow payments and charges for title insurance.

One way to handle closing costs is to pay them out of your own pocket. The second way is to roll the closing costs into the loan, which many homeowners have done.

"Just because you can roll your closing costs over into the new loan doesn't mean it's free," Jarrell said. "People think, 'I don't have to come up with any money at closing.' That's because we roll it over into your loan."

Now you've got to figure out whether that's worth it.

"On the one hand, I've just increased my loan balance by the amount of the closing costs, but I'm saving so much on interest that I don't care," Jarrell said. "The benefit of the refinancing outweighs the cost."

A third method of dealing with closing costs is through what's called "no-cost refinancing."

The name is a misnomer, Jarrell said. "There's no such thing as a free refinance," he said.

In a no-cost refinancing, "you're financing your closing costs through the form of a higher interest rate," Jarrell said. "The typical no-cost refinancing is 1 percentage point higher than a regular refinancing. All you're doing is managing the cash flow."

Length of stay

How long you plan on staying in your home also is important in deciding whether a no-cost refinance would work for you.

"The longer you plan on staying in your home, the more this method of refinance will cost over time vs. coming up with the cash today," Gumbinger said.

Length of loan

In refinancing, be careful that you don't sabotage your original intent: to save money.

For instance, don't stretch the terms of your new loan.

"If you have five years into a 30-year mortgage and you refinance on another 30-year loan, it's very important that you step up the payments and make efforts to knock that balance down because if you take 30 years to pay off the refinanced loan, then you've taken a total of 35 years to pay off the home," said Greg McBride, financial analyst at "That extra five years you take to pay off the loan will more than offset the savings from the refinancing."

If your mortgage payment isn't straining your budget, but you just want to pay off your loan more quickly, consider a 15-year fixed-rate mortgage.

"It saves you a lot of years of making payments, and you save interest," McBride said.

During the first five years of a 30-year mortgage, 2 percent of your payments are going toward the principal, Jarrell said.

"The rest is interest," he said. "In the first five years of a 15-year loan, you pay 20 percent of the principal."

The tradeoff with a 15-year mortgage is that your monthly payment will be higher because you're paying off the loan over a shorter period.

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