REFINANCE YOUR HOME?
By MARY ANNE COLE
With mortgage interest rates dropping, now may be a good time to refinance. Refinancing has some great benefits, but it also costs money, so it’s worth taking a careful look at how deep the water is before you jump in the refinancing pool.
Here are answers to 10 questions you may be asking about whether refinancing is the right choice for you.
Q: What are the benefits of refinancing?
A: The most obvious benefit is the chance to lower your monthly payment or reduce the time it takes you to pay off your mortgage. Many homeowners find that they can shave several years off their pay-off time if they refinance while keeping their payments the same. Rates for 15-year mortgages are generally lower than those for 30-year mortgages, so depending on the difference in the rate between your old mortgage and the new one, you can often refinance a 30-year mortgage to a 15-year mortgage without increasing — or increasing much — the amount you’re paying each month.
Alternatively, you can refinance to a lower rate with a 30-year mortgage and get a lower monthly payment. While the rate you’ll get will be slightly higher than you would have had with a 15-year mortgage, you always have the option of paying more when times are good and going back to the minimum payment during months when your cat’s vet bill goes into four figures or your car starts making sounds like it has a fur ball. However, remember that you’ll be extending the pay-off time of your current loan.
Q: Well, if my monthly payment will be lower if I refinance, that sounds like a no-brainer. Is it?
A: That’s really oversimplifying, just as when a car dealer tells you that you can have a new car with a lower car payment than you’re paying now and fails to mention that your current loan pays off in two years and the new loan will take seven. That means you pay a lot more over the long term.
If all you’re interested in is a lower payment now, and you’re going to extend the length of your loan to get it, you may be making a decision that’s not financially sound in the long run.
Q: I’m ready! Where do I sign up?
A: Not so fast, Quickdraw. Refinancing involves the same closing costs you ran into when you bought your house and can easily run to 2 to 4 percent of the amount you’re refinancing. You’ll need to do some fancy figuring to be sure that the several thousand dollars you’ll have to pay won’t erase the benefit of a lower interest rate. Although most mortgage loan companies and banks will let you roll this amount into the loan, that doesn’t mean it’s free. Another thing to keep in mind is that, like anything else, the better your credit, the better the rate you’ll get—and if you have bad credit, you probably won’t be able to refinance at all.
Q: So how can I tell whether it’s a good idea to refinance?
A: First of all, if you’re planning to stay in your house for less than a year, you should probably forgo refinancing because of the closing costs. But let’s assume you’re going to be in your house for a while and start with a straight refinance, with no cash out, since that’s the easiest one to figure out. This method is a little different from others you’ll see, but it’s the clearest and easiest apples-toapples comparison you can make.
Step 1: Determine how many months of payments are left on your current loan.
Step 2: Ask your bank (or your financial advisor or someone who’s a whiz at Excel) what the monthly payment would be on the new loan at the new rate, with the closing costs rolled in, if you paid it off in the same number of months as you have left on your current loan.
Step 3: Is that payment less than you’re currently paying each month? Then you might want to go for it. Is it more? Hmmm ... maybe not.
Q: I have a reasonable amount of equity in my home. Can I take some cash out when I refinance?
A: It’s a good idea to limit taking cash out to paying for long-term investments such as needed home improvements or college tuition, or to paying off higherinterest credit cards. This last one could be an especially good financial move if you have a lot of credit card debt, since you’ll refinance the money you owe to a lower interest rate than you’ll get from any credit card company — and you’ll be able to deduct the interest you pay on your federal tax return. However, putting up your house to finance credit card debt is a serious move, and you should do so only if you’ve made the pledge not to run up your credit card debt again.
One other thing to keep in mind is that, in Texas, any mortgage — even a first mortgage — that involves taking cash out is called an equity loan, and you can have only one at a time. You won’t be able to get a “second mortgage” in the form of another equity loan if your first mortgage involved getting cash out.
So if you run up your credit cards again or need more cash out for any other reason, you’ll have to refinance the whole balance of your mortgage — and interest rates might not be as good when that need arises. See also the question below about taking cash out to pay off credit card debt, because it’s not always a good idea.
Q: How can I tell whether taking cash out is a good idea or not?
A: Again, let’s take the easy scenario first, the one where your cash out is going into home improvements or college tuition — anything but paying off credit card debt. In this case, it’s a twopart decision. The first part you can make without the benefit of a calculator or a CPA: Is what you’re going to spend the cash on worth taking out a loan at X percent? (Don’t assume the tax deduction will be more than it really will: For example, if you’re in a 25-percent tax bracket and you take $20,000 cash out on a 6- percent, 15-year mortgage, the tax deduction on the approximately $1,250 interest you’ll pay in the first year will be only about $310, and that $20,000 will cost you an additional $400 to $800 in closing costs.)
The second part of the decision is the same as if you weren’t taking any cash out: What will doing the refi do to your current loan? You can still use the steps for the straight refi, using the loan balance before you add on the cash-out amount, to answer that part.
Q: I want to take out cash to pay off credit card debt. How can I figure out whether that’s a good idea or not?
A: If you have significant credit card debt and the interest rate you get on a refinanced loan is lower than your current interest rate, the chances are good that it will be to your benefit to refinance and take cash out to pay off your credit cards.
But if the interest rate is higher, you’ll have to do some high-class figuring to determine if it’s worth it because you’ll likely be refinancing a large amount (your current mortgage balance) at a higher rate and a smaller amount (your credit card balances) at a lower rate. For example, refinancing a $100,000 mortgage balance that’s currently at 5 percent, and $40,000 of credit card debt that’s currently at 8 to 9 percent, with closing costs added, at 6 percent — only a point higher than the original loan — doesn’t turn out to be a good idea, even with the tax advantages included.
Q: I have an adjustable-rate mortgage, and the initial low rate is going to adjust upward in a few months. Should I refinance now?
A: Adjustable-rate mortgages are a great idea for people who don’t plan to stay in their homes longer than the low initial rate will be in effect, but if your plans change and you want to stay in your home after the rate adjusts upward, you may want to look at refinancing the balance to a fixed rate. It will still be higher than the initial low rate you were paying, but it will probably be lower than the adjusted amount of your current loan, and you won’t have to worry about the rate’s changing any longer.
The problem right now is that home prices are sliding a bit, even in San Antonio, and unless you bought your home with a good down payment of 10 to 20 percent, you may find you’re “upside down” on your loan — owing more on your mortgage than your house is currently worth. Because of that “subprime mortgage” crisis you’ve been hearing about, it’s going to be pretty much impossible to find a lender who will refinance your house for more than it’s worth. You may have to bite the bullet and pay the higher mortgage rate for a while until your home value recovers before you can refinance.
Q: Should I stay with the same lender or find another one?
A: It’s always a good idea to shop around, but don’t assume that your current lender won’t refinance for you. Often, they’d rather refinance than lose the loan, and you may be able to negotiate lower closing costs with your current lender than with a new one.
Q: What else should I remember?
A: If the balance of your refinanced loan is 80 percent or less of your home’s value, double-check to be sure that they don’t include Private Mortgage Insurance (PMI) on your loan. PMI costs you money, but it is not required if your balance is 80 percent or less of your home’s value. Even if you’re not planning to refinance, if you bought your home with less than 20 percent down and you’ve built up at least 20 percent of equity since then, you should call your mortgage lender to have the PMI removed.
Some lenders will try to oversimplify the benefits of refinancing, so learn as much as you can, heat up your calculator and make sure it’s the right choice for you.
Before acting on the information in this column, contact your financial advisor for advice that is directly related to your own situation.
