Should you refinance?

With the recent drop in interest rates, refinancing home mortgages has become a booming business again. Some lenders used to use a rule of thumb that it is beneficial to refinance your home when there is a difference of at least two percentage points between the old mortgage and the new one.

Following this “rule” may cost the homeowner a lot of money. Actually, a small percentage point spread may justify refinancing if other factors are present.

The first factor to consider is closing costs. Pre-payment penalties on the old loan, plus loan points and fees on the new loans may total 2 percent to 4 percent of the loan and are usually paid when the new loan
closes. These costs are often added to the new loans, making it larger.

The second factor is the length of ownership. The closing costs can be spread over the period of the loan. The longer the projected period of ownership is, the smaller the spread between the old and the new mortgage can be. The owner’s income tax bracket is a factor. Most interest on mortgage loans is deductible. There is a restriction on loans greater than 1 million, and $100,000 for home equity loans. The higher the tax bracket, the greater the effect on one’s taxable income.

The next factor is the type of mortgage selected. For most people who are thinking of a traditional 15- to 30-year mortgage, the choice is between a fixed or variable loan. Fixed rate loans currently are at recent
historical lows. Rates are in the 4.7 percent to 5.25 percent range. This is lower than many variable loans of a few years ago and variable rates are a ticking bomb in some cases.

Again, the length of ownership is a factor here. If the owner plans to sell the property in two to three years, a variable loan may be better.

Variable loan rates are typically less than fixed rates, but can rise with their assigned index.

Fixed-rate mortgages are for long-term owners who want equal payments.

They offer stability and potentially lower rates over the length of the plan.

There are many other variations of financing or refinancing. The “seller take back” mortgage is when the seller provides all or part of the financing as either a first or second mortgage. A motivated seller with significant equity in a property may be glad to help provide financing in order to get a sale.

Today, many homes on the market are bank-owned properties, and the banks want to move these properties off their balance sheets.

A wraparound loan is when the seller keeps the original low-rate mortgage.

The buyer makes payments to the seller who forwards the payment to the lender holding the original loan. This is a tricky transaction and full of potential problems.

A land contract is when the seller retains the original mortgage. There is no transfer of title until the loan is fully paid.

A buy-down subsidy is when the developer or other party provides an interest subsidy that may lower the monthly payments during the first few years of the mortgage. It may help the developer sell units in the project.

A balloon mortgage is usually a fixed-rate mortgage written for a short period, with the entire mortgage coming due and requiring a sale or refinance.

A graduated payment mortgage is a mortgage requiring lower initial payments, gradually increasing during five to 10 years, and usually leveling off thereafter. Sometimes first-time homebuyers find it easier to qualify for this kind of mortgage.

A reverse annuity mortgage, also called an “equity conversion,” is used when the property owner needs income and a lender makes monthly payments to the owner using the property as collateral.

Another variation is “rent with option to purchase.” Here the renter pays an option fee to purchase the property at a specified time and at a specified price. Rent may or may not be applied to the sales price.

Creative sellers and motivated buyers can literally design many variations of these mortgages. However, most qualified buyers don’t need them and shouldn’t use them.

As with most financial transactions, buyer/borrowers should work with knowledgeable and experienced professionals. There are significant variations in fees and in terms of mortgage loan. Shop around. Ask questions. Compare the alternatives and try to make comparisons.

A 1 percent reduction on a $300,000 mortgage will save the homeowner nearly $64,000 in interest in 30 years. Is it worth the effort? I think so.


Source

In dropping the interest rate the homeowners will happy for that.