The rush to refinance: Lower rates can save money, but you have to do the math first

By Barney Burke of The Leader

Mortgage rates have dropped so low and so quickly that a Port Ludlow couple actually refinanced their home twice in a matter of weeks.

Alan and Marcia Steward reduced their interest rate from 6 5/8 to 4 3/4 in two steps, resulting in a savings of about $300 a month, they estimated. "It's like a raise," said Alan, a retired union sheet metal worker. "If it comes down again we'll do it again."

Because both refinances were with the same lender, First Federal Savings & Loan, the cost of refinancing was less, noted Tracy Tally, residential loan officer. "She took us step by step through the process," said Marcia, a retired medical secretary.

Alan and Marcia chose a conventional, 30-year loan with a fixed interest rate. "We never do an adjustable; we always do fixed," said Alan. "You never know."

The couple said that their new loan is less than the interest rate on their first home, which they bought in 1966.

"They're just about as low as they're ever going to go right now," said Craig Dorr, a marketing manager for American Marine Bank. Savers' deposits are loaned out for mortgages at a slightly higher rate, he explained, and interest rates on savings are pretty low right now.

15 or 30 years?

Rates change every day. But last week, a nonscientific survey by The Leader showed that interest rates for conventional, fixed-rate 30-year loans were in the 4.67 percent ballpark, while 15-year loans were a bit lower, around 4.41 percent.

Often, a 15-year loan offers a significantly lower interest rate than 30, but the margin is much closer now.

Dorr explained that mortgage rates are based on treasury bills (a type of debt financing used by the federal government). Right now, there's little difference between rates paid to holders of 30-year treasuries versus five and 10 years, he said, so lenders aren't giving much of a discount on 15-year loans.

A new 30-year loan might save someone about $168 a month in the hypothetical comparison in this story. A 15-year loan would increase the monthly payment by about $305, although you would pay about $100,000 less in interest because the 15-year loan retires the principal so quickly.

If you're not comfortable signing up for a 15-year loan, you can still save quite a bit by getting a 30-year loan and paying it off sooner than required. This is a good reason to make sure your loan doesn't have a prepayment penalty.

Some people suggest accelerating your loan repayment by paying half of it every two weeks, which works out to 13 payments a year instead of 12.

Another option is to simply round the payment up, say to $1,100 in this example. Paying $1,100 a month instead of $1,031.36 would pay this example off 45 months early, saving you about $46,000, although those future dollars aren't worth as much as today's dollars.

The break-even point

One thing everyone seeking to refinance his home should check is how long it takes to recoup the cost of the new loan.

The Leader contacted half a dozen conventional lenders who offer refinancing and asked about the cost of getting a new $200,000 loan with no points (a "point" is a one-time fee equal to 1 percent of the loan amount; points are in addition to other closing costs).

As of last week, those lenders gave a range of closing costs from $2,000 to $5,000, though the most common estimate was $2,500. "A lot of people finance that fee," said Dorr.

If refinancing saves you $300 a month, it would take eight months to reach the break-even point. If it takes more than three years to break even, Dorr said, refinancing might not make sense.

Not for everyone

Refinancing does not make sense for everyone, Dorr cautioned. If you're planning to move and/or sell in a couple of years, it might not be worth it, he said.

And if you have a very small loan balance, the closing costs could still be a couple of thousand dollars because some of those fees, such as an appraisal, would be the same as for a larger loan, Dorr said.

People with a small balance, say $75,000, might be better off getting a home equity line of credit to replace their straight mortgage. Some lenders, Dorr said, are offering these loans at less than 4 percent and with no fees. Those loans typically have adjustable rates that can be converted to a fixed rate.

Among the people who should probably refinance are those with large adjustable mortgages or mortgages with "balloon" payments due in five or 10 years, said Dorr. Those kinds of loans have been a key factor in the foreclosure epidemic.

Dorr notes that a lower mortgage payment is not everyone's prime goal. Some borrowers want to finance home improvements - such as insulation to cut energy use - that can add value to the home as well as reduce energy bills.

But a "cash-out" refinance, said Dorr, is a little riskier for lenders, and thus the rates and equity requirements are a little higher.

To get a straight refinance, you typically need a loan-to-value ratio of 80 percent. For a cash-out, the requirement is usually 70 percent unless you're willing to pay more, said Dorr.

Plastic debt is an issue

Some people do a cash-out to pay off credit cards, but a lot of financial advisors caution against that.

"That dress or dinner you bought is now a lien holder on your house," said Laura Piper, president of Consumer Credit and Debt Counseling Service.

Although many people find that they can deduct mortgage interest from their income on their federal taxes, you can end up paying a lot more interest than you would if you didn't run up your credit cards.

Moreover, people are finding out how hard it is to convert plastic debt to a larger mortgage in the midst of falling real estate values.

"People are coming to us because they are in that exact situation," said Piper. They've used their homes as credit cards, she said, sometimes paying off as much as $30,000 in plastic debt in the past. "They've always been able to refinance," she said, but they find that they don't have the equity to do it again - or the cash flow to make the payments. She urges people in that situation to get financial counseling.

Before you apply

Almost every lender will tell you to make sure to have your credit history in good shape before applying for a mortgage.

You can request reports from all three agencies for free once a year by calling 877-322-8228 or visiting www.annualcreditreport.com. Each of the agencies will also give you your credit score, for a small fee.

A FICO (Fair Isaac Corp.) score of at least 620 is required to get a mortgage, said Dorr. A score of 720 or more is needed to get a mortgage with the most favorable terms.

Although the formula is proprietary, one of the things that can reduce it - in addition to late payments and too much debt - are too many credit applications.


Source

The rate is quiet good that the investors can refinanced easily as they like.