Last week's column urged us all to examine our current home loan to see if it would be beneficial to refinance. Here are some questions that frequently arise whenever refinancing is the subject:
Q: I have always heard that refinancing isn't a good idea unless you can drop your interest rate by at least two percentage points. Is that true?
A: Like many rules of thumb, it can be true, but not always.
The best way to decide on refinancing is to talk with a mortgage lender and let them explain the products they have available and how they can save you money. Short of that, here is my quick and dirty analysis:
- Determine how much it will cost you to refinance. Typically, closing costs are in the range of 2.5 percent of the new loan amount, but sometimes less, depending on the rate you accept. Talk to your lender.
- Determine the annual savings in interest rate if you refinance. Multiply your loan balance by that amount to determine your annual dollar savings.
- Then multiply that amount by the number of years you expect to remain in ownership of that property. That is your expected savings amount. If the expected savings substantially exceeds the cost of refinancing, then it is likely worthwhile to proceed. If not, you can seek to lower your closing costs by accepting a slightly higher interest rate.
Q: How can a lender afford to offer a "zero closing cost" refinance program? Who actually pays for the expenses?
A: If the closing costs are below about 2.5 percent of the loan, then the lender is absorbing the costs internally. In exchange, you will be offered a slightly higher interest rate, which the lender can sell for a slight premium after closing.
In other words, you are actually paying for your closing in the rate you accept.
Q: My interest rate is high at 8 percent, but I only have 9 years left before my loan pays out. Should I consider refinancing, and if so, won't it cost me a lot more in interest over the extended payback period?
A: Yes, you should consider refinancing, regardless of the time period left on your current loan. It is important to remember that almost all loans today may be repaid in whole or in part at any time. That means you can shorten the length of your payback period by making larger principal payments if you choose. So you could refinance from 8 percent down to less than 6, then increase your monthly principal payments to cause the loan to payoff in 9 years if you wish. You'll save money with each payment, and the loan will still payout on schedule. And if you simply kept the payment amount where it is today, your new loan will pay out in less than 9 years.
Q: Would it benefit me to get a 15 year loan instead of a 30 year loan?
A: Typically, the shorter the term of a home loan, the lower the interest rate. But as rates approach zero, a compression occurs in the rate differential, so that there is almost no difference in the rates for these two loan programs. In fact, I recently saw where the same lender was offering a slightly lower rate for the 30 year program than the 15 year version. While that makes no sense, it underscores the importance of shopping around to find the best deal.
Q: What if I just refinanced six months ago. Is it OK to do it again now that rates are lower, or do I have to wait for a full year?
A: Lenders claim they lose money if a loan pays out in less than a couple of years. But few borrowers in today's market would accept a loan that carried prepayment penalties.
So as long as your current loan carries no prepayment penalties, there is no limit on the number of times you can refinance.
Q: I heard on the news that the current credit crunch has made it almost impossible to borrow money for a home refinance. Is this application just a waste of my time?
A: Not at all. For well qualified borrowers with good credit there is no shortage of loans whatsoever. Lenders are relying on your credit score more heavily as an indicator of your creditworthiness, so it's a good idea to pull your report and score before you begin rate shopping.
Q: On a refinance, can I just apply to lower the rate and skip the appraisal part?
A: While some lenders do offer a streamlined refinance program with lesser requirements, most refinance loans require full documentation in order to get the best rate and terms. That means a full appraisal as well.
Q: Is it safe to deal with internet lenders? Can I save money or get a better rate over the world wide web?
A: Call me old fashioned, but when it comes to borrowing this much money, I want someone that I can sit down with and talk to face to face. I have tried numerous times to borrow money over the internet, and have been disappointed in the past.