LETTERS From CAMP Rehoboth |
Some Small Notes on Refinancing |
by Cheryl Normandeau |
The refinance market is booming, with interest rates at 20-year lows in the industry. Before you begin the refinance process, do a little research to save yourself some time and money down. When should you re-finance? Traditionally, the decision on whether or not to refinance has meant balancing the savings of a lower monthly payment against the costs of refinancing. In recent years, lenders have introduced "no cost" and "low-cost" refinancing packages that minimize or eliminate the out-of-pocket expenses of refinancing. (These refinancing packages compensate usually with either a higher interest rate, or by including some or all of the costs in the amount that is financed.) Depending on your need for cash flow, it may make sense for you to refinance with a less than 1% reduction in interest rate. A reduction of less than $100 per month may indeed make sense within your household. The age old rule-of-thumb of at least 1 percent less does not always hold true. How long you expect to stay in your home is a factor to consider. If youll be moving in a few years, the month-to- month savings may never add up to the costs that are involved in a refinancing. To determine this, calculate the total cost of refinance and divide it by the amount you will save each month. For example, lets say your cost of refinance is $1,800 and your new monthly payment will save you $125 per month. This means that for the savings to break even, it will take 14.4 months of new payments. If you plan to move within a year, this may not be the best idea for you. Another point to consider is tax advantages or effects on your income tax. Call your tax advisor for help with this decision. How many points must you pay? In refinancing, lenders usually offer a range of interest rates at different amounts of points. A point equals one percent of the loan amount. For example, three points on a $100,000 mortgage loan would add $3,000 to the refinancing charges. Another way of looking at the definition of a point is that it is pre-paid interest. Shopping for points as well as interest rates may save you money. Most people call and ask only for the "zero point" rate. This may not be the best bargain for your individual needs. Generally, one point will buy down the rate by a percent. On some days, one point may actually buy you more. To decide what combination of rate and points is best for you, balance the amount you can pay up front with the amount you can pay monthly. The less time that you keep the loan, the more expensive points become. If you plan to stay in your house for a long time, then it may be worthwhile to pay additional points to obtain a lower interest rate. Some lenders may offer to finance the points so that you do not have to pay them up front. This means that the points will be added to your loan balance, and you will pay a finance charge on them. Although this may enable you to get the financing, it also will increase the amount of your monthly payments. How would it affect your taxes? With lower interest on your home loan, you will have less interest to deduct on your income tax return. That may increase your tax payments and decrease the savings you might obtain from a new, lower-interest mortgage. You should be aware of an Internal Revenue Service (IRS) ruling with respect to points paid solely for refinancing your home mortgage. IRS regulations require that interest (points) paid up front for refinancing must be deducted over the life of the loannot in the year you refinanceunless the loan is for home improvements. This means that if you paid a certain number of points, you would have to spread the tax deduction for those points over the life of the loan. If the refinancing is for home improvementsor a portion of the loan is for this purposeyou may be able to deduct the pointsor a portion of the pointsunder certain circumstances. Check with the IRS regarding the current rulings on refinancing. Consider another type mortgage? If you are thinking about refinancing your mortgage, you might want to consider other types of mortgages. For example, you might want to look into a 15-year, fixed-rate mortgage. In this plan, your mortgage payments are somewhat higher than a longer-term loan, but you pay substantially less interest over the life of the loan and build equity more quickly. (Of course, this also means you have less interest to deduct on your income tax return.) If you decide to apply for refinancing with a particular lender, and if you do not want to let the interest rate "float" until closing, get a written statement guaranteeing the interest rate and the number of discount points that you will pay at closing. This binding commitment or "lock-in" ensures the lender will not raise these costs even if rates increase before you settle on the new loan. Most lenders place a limit on the length of time60 days for examplefor which they will guarantee an interest rate. You must sign the loan during that time or lose the benefit of that particular rate. Because many people are refinancing their mortgages, there may be a delay in processing the papers. You may want to contact your loan officer periodically to check on the progress of your loan approval and to see if additional information is needed. How much will my refinance cost? When you refinance your mortgage, you usually pay off your original mortgage and sign a new loan. With a new loan, you again pay most of the same costs you paid to get your original mortgage. These can include settlement costs, discount points, and other fees. You also may be charged a penalty for paying off your original loan early, although some states prohibit this. The total expense for refinancing a mortgage depends on the interest rate, number of points, and other costs required to obtain a loan. Shopping for the lowest rate only does not give you the total picture or the "best deal". Shopping for a lender includes shopping for the best and lowest fees also. When doing comparative shopping, ask questions of all fees of the lender and loan funder. Junk fees on the day of settlement can be frustrating. Cheryl Normandeau is a mortgage loan officer for Norwest Mortgage, Inc. in Rehoboth Beach. She may be reached at 302-227-1865. |
LETTERS From CAMP Rehoboth, Vol. 9, No. 5, May 21, 1999 |