Be Careful When Refinancing!
by Ken Stone
DATE: 03/27/2008
With mortgage rates heading down to levels not seen in more than two years, many homeowners would like to refinance and save money. The big question is: When is it financially beneficial to refinance?
A Realtor friend of mine told me about a client of hers who was being called by their lender to refinance. The details of their current loan were straightforward: a $205,000 fixed rate at 6.5% - with plans to stay in the home for about three years. The lender promised $100 a month in savings for $3,000 in costs. It’s easy to see that without considering the time value of money or tax impact of a lower interest rate, the “break even point” for the loan being proposed is 30 months. With plans to stay in the house for 36 months the value of this refinance to these homeowners is questionable at best.
After learning about this situation, I suggested a no-cost refinance.
These same
homeowners could refinance to 6% and have all their closing costs paid
for by the interest rate. This is the opposite of buying down the rate
(or paying points) – when you buy up the rate it generates revenue
to the transaction that can be used to pay closing costs. This would
allow them to refinance and owe the same amount on their loan, but now
they’d have a new lower rate and payment that would save them
money from day one.
Additionally, should rates decline further they would be able to refinance again with another no-cost refinance. Make sure your lender understands these issues and how to properly structure a mortgage that facilitates your financial goals while providing the maximum financial benefit. A true no-cost refinance involves an above-market interest rate that results in all closing costs being paid for - it does not result in a larger loan amount!
Many homeowners have adjustable rate mortgages (ARMs) and are interested in fixing their interest rate. Consider my client who called last week wanting to refinance his ARM. I called him back and let him know it won’t be adjusting for another three years. Further, even paying costs the best fixed rate I could get him was a full point above his current rate. This means for him to refinance he would voluntarily pay money (or use up equity) to refinance AND the result would be a higher payment. I suggested he save the money and hang tight - it’s what’s in his best interest.
The bottom line is that the current interest rate environment opens the doors - both real and imagined - of opportunity for many homeowners and mortgage originators. Homeowners would do well to carefully and completely consider the financial consequences of a refinance before committing to sign new loan documents. One place to start: find out if no-cost interest rate is lower than your current rate? If so, you could soon have a lower mortgage payment for free.
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