Mortgage Refinance FAQ
Prepayment Penalities Add to The Cost
ARMS that have prepayment penalties will add substantially to the cost of refinancing. A $300,000 loan with a 3% prepayment penalty will demand a fee payment of $9,000.00 for early payoff. If your ARM has such a clause, you should consider negotiating your new loan with the same lender and see if you can get that fee waived. Business conditions in the mortgage business right now are in your favor.
The same applies to an ARM with a balloon payment. These are loans that were sold with the express purpose of forcing a refinancing package when the balloon payment becomes due. Before you go looking for a new loan that will keep you out of balloon payment debtor’s prison, talk to your lender and see what alternatives are available. Many times, people with mediocre credit accepted these loans. After a few years of meeting mortgage payments, your credit may make you worthy of a more reasonable ARM, if not a fixed rate loan
Save Money on Lower Rates Over Time
How long to you intend to be in the house? You’ll be saving money on that lower interest rate only as long as you remain there. If you think you might be moving in a few years, the question becomes “Are the costs of the new loan going to neutralize my savings?” Once again, the prepayment issue comes into play, if you think you’ll be selling the house within five to seven years. You can no longer expect rapid acceleration of housing values to make these sorts of costs immaterial.
Fortunately, in today’s market loan origination costs are negotiable. The lenders need the business. If you are attempting to refinance an ARM into another ARM and think you’ll be moving within ten years, take advantage of one of the seven-year or ten-year ARMs so that you can close out your loan having maximized your interest savings.
Calculate Your Savings Based on Current
You need to calculate your savings based on today’s dollar. The closing costs you’ll be expending (or borrowing) will be in 2007 dollars, while the interest savings you’re realizing will be accruing for many years ahead. Obviously, the dollar in future years won’t have the value of the dollar today. This may seem like an overly complex calculation and, perhaps, splitting hairs – but if you’re going to conduct a thorough analysis of your refinancing savings you have to take inflation into account. There are mortgage calculators available online that will help you do this.
One other figure that may inflate when you refinance is your property taxes. If your loan is based on a new appraisal and valuation, that may appear in the form of a new property tax, depending on how the tax assessment process works in your state. Ask your broker if it is possible that your tax bill will change and if so, you’ll need to calculate that into your savings evaluation.
Look for Payment Caps and Max Rate Increases
If you’re going into another ARM, look for payment caps that hold down the maximum possible rate increase. Many ARMs that were issued during the housing frenzy had caps on your PAYMENT increase, but not on the INTEREST increase. With a loan of that type, your payment may not cover the increase in interest and you could be building up debt even as you think you are paying it down. There were some dangerous components put into many of the “house at any price” loans issued since the year 2000; make sure you get terms this time that you can live with.
If the whole notion of calculating the value and cost of a new loan bothers you, consider talking with your lender about renegotiating the terms of your current loan. If it is an ARM, see if you can get the range of annual adjustments narrowed – and payment caps put in place, if none exist. If it is important to keep the mortgage payments down, see if you can get the note extended and the interest rate reset. Once again, lenders today are out trolling for business. They will be loath to lose an existing loan and may be willing to revisit terms – while you avoid the substantial costs of a new mortgage.
Having a Lower Rate is Best Over Time
To sum up the process in clear terms, refinancing a loan is never worth the effort unless the new interest rate is lower than the old interest rate, calculated over the life of the loan. The break-even period is the number of months before the savings from the lower rate completely offset the upfront refinance costs.
We’ve mentioned some of the secondary cost factors, but here are the basic refinancing loan costs, which are some of the same battery of fees that you faced when you took out your first mortgage. Those are points, loan origination fees, broker fees, and any prepayment penalties. This time out you’ll avoid escrow fees, title fees, appraisals and hopefully, attorney’s fees. Remember, however, that financing the loan costs also has a cost attached to it, and should be incorporated into your “new loan vs. old loan” comparison.
You have to balance the term of the new loan versus the old loan as well. In many cases, this is a financial calculation – for example, if you can refinance into a fifteen year mortgage you will save yourself a lot of money in interest. It is also a life planning issue as well. If you are refinancing at a point where you’ll be paying on the new loan well into retirement, you may want to reconfigure your loan arrangement or consider other options.