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Refinancing Today

Money Manager | Monday, September 15th, 2008
“you shouldn’t refinance unless you can cut at least two full percentage points off your current mortgage rate.”

I’m certain that you have heard the often repeated and erroneous advice from too many self-proclaimed experts over the years. It is blatantly untrue in today’s mortgage markets.

There are three main factors which should be considered when making the decision to refinance a home or to continue with the current mortgage. They are really basic questions that will be the only real reasons to refinance:

1. How much will be saved each month by refinancing at an available lower rate.

2. How much will the lender’s fees be to ssue a new loan, and

3. How long does one plan to stay with that loan (remain in the home).

That last consideration may not seem like a very important point, but it is critical in calculating whether refinancing will actually save money even if at a lower interest rate.

For instance if your payments on a $150,000 mortgage obtained at 8% were to be refinanced at 6.5% for the same period, you would see a monthly savings of $53. Sounds good; that’s another $53 you could put towards paying off one of those incredibly costly credit cards. But, it may not be such a great deal unless you plan to stay in the home for at least four or five more years.

Why? Simple: if that new lender who is so generous with his rate sheet charges you an additional upfront point (1% of $150,000 – $1,500) plus another $500 in other fees, the cost of refinancing is $2,000.

Divide that cost by the amount you are now saving and you get a number of almost 38. That means it will take you more than three years until you just break even. And, that doesn’t take into account the effort and inconvenience associated with refinancing. So, if you plan to move or sell within that 38 – 40 month period, it would not be worth the savings, if any, or the trouble to refinance now.

However, if you plan to stay in the house for at least four to ten or more years, it would definitely make sense to refinance now. The savings add up and become really significant if you stay in the home for an extended period of time; ten or twenty years. In ten years, the total monthly saving adds up to more than $4,000 even after factoring in the refinance costs.

Without factoring inflation or other unforeseen economic fluctuations, twenty years will let you realize a simple savings of almost $11,000!

Of course, like everything else when it comes to mortgages and refinancing, it isn’t always that simple. There are other considerations that make this simple calculation less simple. The above figures only work when the time remaining on the loan and the duration of the new loan are approximately the same. Moving from a 15 year loan that has run for nearly half the term to a 30 year loan at a lower rate will certainly save a substantial amount each month, since the principal is now much lower and with the better rate, the monthly payments will decrease sharply. The down side is not reaching the break-even point until several months sometimes depending on balance and rate, more than a year from the onset. That isn’t necessarily a bad thing and if the moneys you used for the upfront costs wasn’t being applied to a savings account, you really are ahead and will stay ahead for the duration of the loan. By ahead, we mean as far as monthly payments, you will certainly pay out more over the life of the loan. That can be somewhat offset by using as much of the monthly mortgage saving as possible to build savings.

On the reverse, it gets even better. If you had a 30 year high interest mortgage say at 11%, and it has 20 years or more to run, and you move to a 15 year, 7% mortgage, the break-even point comes sooner than the simple calculation would indicate. Applying the figures we have already used, it would indicate the break even point at around 30 months, but the fact is that you would break even in about a year because of the difference in the loan balance. A current economic trend of interest rates rising adds another reason to consider refinancing even if an immediate monthly savings isn’t substantial. Switching now from a variable rate mortgage to a fixed rate may be a wise move. Currently, many variable rates exceed fixed rates available to borrowers. The competition between lenders is extremely fierce at this time and the person seeking a mortgage may be at a temporary advantage. This becomes even more attractive if you have paid down your mortgage at least a third of the loan’s run. With the lower balance and a lower rate, most can afford to shorten the length of the laon and still realize a monthly payment reduction. Even if the payment doesn’t drop that much, a shorter payoff time will mean a lot when retirement rolls around. One of the best financial goals to have is to retire the mortgage before you retire yourself!

Because all this is dependent on so many variables, we do not begin to offer this information as advice for deciding to refinance or not. We strongly recommend that before you put ink on paper, you consult with a mortgage or financial specialist, a lawyer or your personal financial advisor. Maybe all three. Remember, once it is on paper, in most states the “four corners” rule applies. Simply put, the four corners rule is that whatever is actually written into the real estate contract is all that applies and is the final word. So-called understandings between parties or verbal agreements and other non-written terms are not only difficult to prove, but may not matter even if proven. When the biggest and probably most important purchase of a lifetime is at stake, it doesn’t pay to take chances.

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