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Archive for Sunday, July 23, 2006

Homeowners still refinancing

July 23, 2006

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This bit of data arrived via e-mail from the Mortgage Bankers Assn.: Despite the upward drift in mortgage rates, refinancings continue to account for more than a third of all new mortgage applications.

That's surprising because refinancing is most appealing when rates are going down, not up. A lower rate allows a homeowner to replace an older mortgage with one that has a smaller monthly payment.

There are two reasons people would refinance when rates are rising.

The first is to get cash out of a home. Home values have been soaring in the past few years, leaving many homeowners with properties worth far more than they owe on their mortgages. By refinancing with new, bigger loans, even at higher interest rates, these borrowers can pay off older mortgages and have money left over for other things.

This can make sense - sometimes. Rather than move to a bigger home, for instance, a growing family might refinance to get cash to expand the one they have.

But refinancing does not make sense if the money is used for less important things, such as vacations. The long-term interest payments on a 30-year mortgage double or even triple the cost of whatever you buy with that money.

As a rule of thumb, long-term debt should be used only to buy things that provide a long-term benefit.

The other reason for refinancing when interest rates are rising is to replace an adjustable-rate mortgage with a fixed-rate one.

Although fixed-rate loans have been at attractively low levels in recent years, Americans gobbled up adjustable loans anyway - lured by the low "teaser" rates charged during ARMs' first 12 months.

Many borrowers, shocked by their new, higher payments and worried that rates will keep going up, are refinancing to lock in fixed rates while they are still at a reasonable 6.5 percent to 7 percent.

Sounds like a simple decision. But, compared with the switch from one fixed-rate mortgage to another, it's not.

With the fixed-to-fixed move, you look at the monthly payments each requires, then decide whether you'll have the loan long enough for any savings to pay off the refinancing costs.

But the comparison isn't so easy when going from an ARM to a fixed loan, because you don't know what the ARM's payments will be in the future.

The deciding factor isn't a breakeven point you can calculate; it's peace of mind from knowing you won't ever be hit with a big, unexpected payment increase.

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