Good Time to Think About Home Refinancing
Mortgage rates have been edging down for the past six months, and now some rates are at their lowest levels in years. If you are not completely satisfied with the rate and terms of your present mortgage, it might be time to consider a refinance.
In some cases, refinancing a mortgage can improve cash flow, reduce income tax payments and help you save tens of thousands of dollars.
But this is not for everybody. There are significant upfront costs, and those costs are not always recovered through lower monthly payments.
What should you consider when contemplating a refinance?
Before you look for loans, you need to weigh your own financial picture and goals.
First, consider how long you plan to stay in your present house. If you expect to be there longer than one year, a refinance might make sense, depending on your mortgage rate and the rates available.
You also need to closely examine how much equity you have in the home to determine whether a refinance will fly. If you bought the house within the last few years with a 10% or 20% down payment, there is a chance that you don’t have enough equity to qualify for a new loan. The sad fact is that housing prices have slipped in some areas, reducing homeowner equity.
But if you have more than enough equity in your home, look at what you might be able to get out of a refinance besides just a lower mortgage rate.
Do you, for example, have considerable consumer debts, such as car and credit card payments? If so, you might want to pay off the credit cards and car by tapping equity in your home.
That can often reduce your monthly payments and cut your income tax liability. Why? Mortgage interest payments are tax deductible; consumer debt is not. And banks generally charge less for mortgage loans than they do for either credit cards or other consumer loans because their loan is secured by a hard asset.
Shopping around for a mortgage rate can be as simple as looking in the newspaper. The Saturday edition of the Los Angeles Times, for example, compares rates for several types of loans at a wide array of local financial institutions. But you might also want to consult a mortgage banker to find out what kinds of loans are available from less traditional lenders, such as pension funds and insurance companies.
Right now, fixed rate mortgages are being offered at rates ranging from 9% to 10.5%. Adjustable rate mortgages start at much lower levels. Some California institutions are advertising initial rates of 7%, for example.
However, adjustables must be scrutinized more carefully for details on how often the rate will change and what those changes will be based on. (Usually adjustable mortgage rates are tied to a published index, such as the 11th District cost of funds index or the Treasury bill index.) Some financial institutions will adjust the rate every three or six months, while others offer ARMs that only adjust once a year.
The rule of thumb is that market rates should be 1.5% to 2% below what you are paying before you consider a refinance. But that is not always true.
Generally speaking, those who plan to stay in their homes for many years can afford to refinance to get much smaller rate cuts. But, if you plan to only stay in your present home for a year or two, you might need more than a 2% difference to make the refinance worth while.
How long you plan to stay in the home will also determine whether you want a fixed-rate or an adjustable. If you expect to stay in your present home for fewer than five years, there is a good chance that the adjustable rate will be a better deal for you. Typically, with an adjustable you pay substantially lower rates during the first few years until the rate is “fully phased in.”
But rate should not be your only consideration. Upfront fees and points are also an important factor. Although these fees vary, they usually amount to between 1.5% and 3% of the total mortgage amount.
Clearly, the higher the upfront fees, the longer it takes you to recover your costs and start saving money on the refinance. It is important to note that the points--the biggest upfront cost--are often related to the mortgage rate. In other words, a financial institution may give you a low rate, but charge several points. (Points are prepaid interest.)
You don’t want to pay a lot upfront? Most lenders can eliminate the points, but the bank will then charge you a higher interest rate. This doesn’t usually lower your total cost; it just shifts your costs around.
There are other costs that almost always must be paid upfront. Those are the relatively minor, one-time fees for appraisals, loan applications and the like. These fees also vary institution to institution, but they usually amount to at least a few hundred dollars.
To get the best deal, you need to be well informed and prepared before going to a financial institution.
Some help can be found through HSH Associates, a mortgage information company. They’ll provide you with a 12-page “Refinance Kit” for $3, which has work sheets that will help you determine how much you’ll pay for a loan, depending on the interest rate and loan amount. It also includes a checklist that delineates all the potential fees that might be charged by your financial institution.
To get a copy, send a check for $3 to HSH Associates, 1200 Route 23, Butler, N.J. 07405. The company also sells a more extensive pamphlet that goes through all the available types of loan options and features. That’s the “Homebuyer’s Mortgage Kit,” and it’s $18.
Kathy M. Kristof welcomes readers’ comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls. Write to Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.
