Is It Time To Refinance Your Mortgage?
It's common for mortgage rate quotes to vary by a full percentage
point (e.g. one bank will charge you 5.5% interest, another will charge
6.5%.) For a $200,000 house financed with a 30-year mortgage
loan, this 1% rate spread can make a difference of about $50,000
in how much total interest you'll have to pay the bank!
A popular alternative today is the "3/1 Adjustable-Rate
Mortgage." It's usually about 0.5 to 0.75 points lower than the
no-cost loan rate. The first three years are locked
in at the low introductory rate. The rate is
then adjusted once per year, tied to the prime rate or federal bond
rates. There's normally a protective "cap": for example, an ARM can
rise no more than 2 points per year, and no more than 6 points over the
lifetime of the loan.
A 3/1 or 5/1 adjustable-rate mortgage may well be
your best option, especially if you aren't going to stay in your home for
longer than those 3-5 years. Beware the low rates you'll see advertised
for "1-Year Adjustable-Rate Mortgages", because those are usually "teaser
rates" that jump about 2% after one year.
Most loan professionals would recommend a 30-year
mortgage. It's a safer play, something you should consider
if you want predictable payments. A 15-year mortgage has a lower interest rate,
but monthly payments will be lower for 30-year mortgages because the loan is
spread out for a much longer period of time. You can then invest those
monthly savings, and let compound interest build up a nice little nest
egg.
Whether your mortgage is for purchasing or refinancing, here's the
facts and strategies you need to consider:
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Is It Time To Refinance Your Mortgage? 
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Time to complete:
| Take your time! |
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Money you'll spend:
| Usually $300-$800 if you wind up applying for refinancing or a new home loan |
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What you'll get:
| Potentially thousands of dollars in payment savings |
Mortgage Facts and Strategies:
Low-fee loans. Try to find a loan that costs you only $2,000 or $3000 to refinance,
rather than the $6,000 that some lenders charge. You
can fold this cost into the loan,
instead of paying it up front. Ask about all
closing costs up-front (i.e. loan originationfees, application fees and
appraisal fees.) Don't pay processing fees, underwriting fees,
wire transfer fees and funding Fees because these fees are usually overhead
costs that the lender would like to pass on to you!
- Time it right. The standard
"rule of thumb" is to consider refinancing whenever interest
rates fall by a percentage point or two. A better rule is
to wait until the loan rate
drops enough that you'll save at least $5,000 to $10,000 over
your predicted term of the loan, which could be up to
thirty years, or very short if you think you'll be moving soon.
- Check the fine print. It may have a prepayment
penalty, which you'll have to pay if you refinance in the future (usually
the penalty expires after a few years.) Many
lenders will tell you that a prepayment penalty gets you a lower interest
rate, but you should shop around to see if you can get a good low rate without
a prepayment penalty. Fortunately, most prepayment penalties end after
3-5 years.
- Consider your future. If you still owe a lot
of money on your mortgage, it's important to pay close attention
to refinancing; if not (or if you'll be moving out in a few
years) refinancing is less important. A refinancing over
twenty years is about ten times as lucrative as it would be over two
years.
- Consult expert predictions. If economic experts are predicting that mortgage rates will
continue to fall, you can wait; otherwise, you should consider
locking in the current rate by refinancing immediately. Recent
comments by Alan Greenspan, the government's most important economic
policymaker, indicate that mortgage rates aren't likely to drop any lower and may
soon rise.
- Shop the Internet. The Internet is usually the best place to
get a home loan. Rates are usually at least 0.25% lower (which can translate to
thousands of dollars over 15-30 years) and there are trustworthy sites.
- Online services. You can use online services
that objectively analyze what would happen when you apply to
various types of mortgage loans: they'll list what you'll
pay for each type and length of mortgage.
- Get cash. You can cash out some of your
home equity at the same time you refinance your mortgage.
- Shop "direct lenders". These
direct lenders such as CountryWide
are better than broker sites like LendingTree.com that promise to
get you offers from three or four different lenders. The trouble
with that business model is that you don't know whether you're
being connected with four low-rate lenders, four high-rate lenders, or
something in between. The best strategy is to seek multiple loan
offers from direct lenders.
- Consider ARMs. The "3/1 Adjustable-Rate
Mortgage" (ARM) is about 0.25 to 0.50 points lower than a fixed rate mortgage. The
first three years are locked in at this low rate, which is then
adjusted once per year, tied to the prime
rate. It would allow you to refinance your home
now and save money, rather than waiting for non-ARM rates to fall. A
3/1 or 5/1 adjustable-rate mortgage is a good play
if you aren't going to stay in your home for longer than those 3-5 years.
"10/1" ARMs are also common, as are ARMs with
no initial fixed-rate period.
- Fixed mortgages are safer. On the other hand, the probable future rise in interest rates would
not be good for those who currently
are in ARMs. We can hope the rates won't be steep: the last time
the 30-year fixed rate rose above 10% was 1988-89; it rose above 15% in
1981-1982. In summary: if
interest rates rise, refinancing now to a fixed mortgage would provide
a homeowner a good combination of (1) a reasonable interest rate, (2) fixed payments
that won't rise, and (3) the resulting "peace of mind."
- Off-season savings. The off-season for home hunting (usually winter in the north,
summer in the desert) is a good
time to refinance your home, because bank fees will often be reduced during
winter by $250 to $500.
- Rate locks. You can use "rate locks" to make sure a loan rate doesn't change.
You can then take a few months to look for more competitive loans.
Short-term rate locks (around 60 days) are usually free.
- Tax deductions. After you've financed your home, remember that you can deduct some
loan fees from your taxes, such as commissions, closing costs, penalties, loan fees,
"paid points," and of course mortgage interest. If you fold all
closing costs into the loan, they all become tax-deductible.
- Adjust your terms. You could do a 30-year
refinance to lower your monthly payments, or maybe a 15-year refinance
to get the mortgage paid off sooner. Terms of 10, 20 and 40
years are also possible though they are usually unadvertised.
- Interest-only loans. You only pay interest for the
first 5-7 years, then your payments jump as you start paying off the
principal. It's good for people who expect their income to increase in
the future.
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Further Reading:
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