Refinancing Your Home: Current Issues and Useful Tips (part 1)

 

Small houses and skyscrapers - Yokohama

Today’s mortgage rates are at or near historic lows and represent a great opportunity for many homeowners to lower their monthly payments by refinancing the principal balance of their mortgage.  Before making any final decisions, please consider the following three issues.

1. Refinancing will involve closing costs that will vary in size based upon the amount refinanced, among other factors. Be sure to calculate the monthly savings that will be realized and the number of months it will take to recapture the closing costs. For example, if you’ll save $100 per month by refinancing and the closing costs associated with the refinance will be $1000, the recapture period is 10 months. Then assess the probability that you will remain in your home for at least as long as it will take to recapture the closing costs. The lower the probability and/or the larger the number of months to recapture the closing costs, the smaller the potential benefit of refinancing.

 

2. Mortgages are structured so that the interest expense is front loaded, while the principal portion is back loaded. In other words, during the first half of a 30 year mortgage, the vast majority of your monthly payments will be applied towards the interest owed. Consequently, the fewer the number of years that remain on your current mortgage, the more careful you need to be when considering a refinance.  If you have already made payments for a period equivalent to 80% or more of the duration of your current mortgage (e.g., only 6 years or less remain on the existing 30 year mortgage), the majority of your current mortgage payment is going towards the reduction of the principal portion of your loan. Since the goal of every homeowner is to pay down the principal balance, does it make sense to refinance the principal balance, when your current payments are primarily reductions to the principal balance? Remember, if you refinance, your payments will revert to being reductions towards the interest owed.

 

3. Shop around for the best rates and closing costs. Don’t choose a lender just based upon the interest rate, since you need to consider all of the closing costs too. While some lenders will attempt to attract customers with a lower rate than the competion, very often they are making up the difference in additional fees and other charges. Think of the total cost as the volume of a balloon. Whether the balloon is squeezed or not, the total volume remains the same. Similarly, you may find that although one lender’s rate is lower than another’s, the total approximate cost is pretty much the same. The same thought pertains to “no closing cost” loans. Every lender must make a profit, so if they’re advertising a no closing cost mortgage, be aware they are either charging you a higher interest rate or making up the difference in a combination of ways.  Finally, always start with your current mortgagee, as they may offer a better deal, just to retain your business.

 

Please feel free to add your comments and suggestions, based upon your experiences. The more we share the more everyone can benefit!

Photo courtesy of Flickr and Fakelvis’ photostream.

@homeslouky

 

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