Weigh Pros and Cons Before Refinancing Refi

The financial question facing millions of American homeowners right now is not: Should I refinance my mortgage?

For many of them, it is: Should I refinance my refinance?

According to mortgage securities industry estimates, slightly over one-half of the country’s outstanding home loans carry rates of 7% or higher.

One out of four loans carries a rate over 71/2%, one out of eight a rate of 8% or higher.

During the 1990s, the percentage of homeowners with rates above 8% was much higher, but many of those loans were refinanced in the “refi boom” years of 1993 and 1998.

But now many refinancers--even those who closed on new loans within the last 12 months--are looking at fixed 30-year rates of 63/4% and below, 15-year rates of 61/4% and adjustable-rate mortgages in the 5% range. One of those is Doug Duncan, chief economist of the Mortgage Bankers Assn. of America.

He has a 71/4% 30-year fixed-rate loan, and he’s about to refi to a 15-year fixed-rate loan under 6%.

Duncan, who is cutting his rate and term as part of a financial plan to become mortgage debt-free in the years ahead, says there are “huge numbers” of baby boomers and other homeowners facing similar choices.

Low interest rates this fall are also focusing new attention on a technique that enables homeowners in the above 7% mortgage-rate bracket to refinance, with little or no money out of pocket.

Known as “zero-cost” refis, these transactions involve no appraisal, credit, title or other closing fees at settlement.

Those standard fees, plus compensation for the mortgage broker, get rolled instead into the interest rate on the note.

The rate, for instance, might be one-quarter of a percentage point higher than the otherwise prevailing rate for a particular type of mortgage.

Last week, zero-cost refis were available at rates so low that even some homeowners with rates in the 7% range could cut their monthly payments immediately, with nothing out of pocket: 15-year mortgages at 61/2% with no fees, 30-year loans at 6 7/8% with no fees and hybrid “7/23” adjustable-rate loans at 6 3/8%, also with no fees.

In the case of the “7/23” hybrid, your rate would be 6 3/8% for the first seven years, then shift to an adjustable-rate for the remaining 23 years. Most borrowers using 7/23 hybrids know that they’re not likely to remain in the house for more than seven years, and essentially are taking out a low-cost, medium-term fixed-rate mortgage.

One of the country’s top experts on zero-cost refis, Henry Savage, president of Alexandria, Va.-based PMC Mortgage Corp., says the concept can be a big money saver, but it has some potential pitfalls as well.

For example, some lenders market zero-cost transactions that tack the closing costs and fees into the loan principal balance, rather than as a premium on the rate.

Consumers who have to sell within a few years of refinancing then find themselves with less equity in their house than they thought.

Prepayment penalties are another feature to avoid, Savage says.

Refinancing your previously refinanced loan can trigger some surprise tax issues as well. For instance, although many borrowers assume they can deduct interest without limit on larger and larger refis, this is not true.

You can deduct interest on your “acquisition indebtedness”--your original mortgage principal balance minus the principal you’ve already paid off--plus another $100,000 of “home equity” debt.

Refi proceeds that are used to make substantial improvements to the house count as additions to acquisition debt.

Say you bought your house with a $200,000 mortgage in the 1990s, paid off $10,000 in principal, and later refinanced into a $275,000 loan, the net proceeds of which you used for personal expenditures.

Your last refi moved you within $15,000 of your interest-deductibility limit ($200,000 minus $10,000 equals $190,000. Add $100,000 for home equity debt and you’ve got a $290,000 cap.) Should you refinance again this round, and seek to pull out substantial cash, you could exceed your legal limit.

Martin Nissenbaum, national director of personal tax planning for the accounting firm of Ernst & Young, says that homeowners in high-cost housing in high-appreciation markets are the most likely to bump into this limit.

Nissenbaum also advises refinancers to review other tax rules affecting their transactions.

For example, “points” on refinancings are not deductible in the year they are paid. They must be deducted on a pro-rata annual basis over the term of the loan.

The good news here for serial refinancers is that you can write off the full balance of your non-deducted points from your previous refis against your taxes this year.

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Distributed by the Washington Post Writers Group.