Thursday, October 29, 2009

Refi Now Before Rates Climb

This is my Bloomberg column on how to refinance your home mortgage:

Commentary by John F. Wasik

Oct. 29 (Bloomberg) -- If you need to refinance your home mortgages, don’t wait.

It’s not time to play chicken. Lock in the best deal now. Mortgage rates have climbed over the last two weeks, according to mortgage buyer Freddie Mac of McLean, Virginia. At a 1960s- like national average of 5 percent, the 30-year rate isn’t far from its historic low of 4.78 percent, reached in April. As the economy heats up, it’s far more likely that rates will climb.

Not only can you save every month with refinancing, over the life of the loan your total interest payments drop substantially. Increased cash flow could be the single-best excuse to refinance if your total loan expenses are reasonable.

Let’s say you have a $300,000 mortgage and you are paying $1,847 a month on a 30-year, 6.25 percent loan.

You can obtain a 5.25 percent, 30-year loan and knock down your monthly payment to $1,656, according to the Bloomberg mortgage calculator. The $2,292 annual savings would do nicely in an emergency, college or retirement fund.

If you stay in your home for 30 years, then you will save almost $69,000 in interest by refinancing. On the 6.25 percent loan, you will pay about $365,000 in interest alone -- in addition to principal.

When I got a refinancing offer letter from my bank recently, I was excited. Instead of paying 6 percent on my 30- year loan, I could refinance to 5.24 percent.

Initial Offer

My monthly payment would drop from $714 per month to $572 for annual savings of more than $1,600.

I called the bank with great hope. They also offered to waive the origination, appraisal and credit-report fee.

Upon inquiring further, it became clear that not all of the loan costs were disclosed in my cheery little letter.

Total expenses would be about $3,000 and the bank would need $750 cash upfront just for an application fee.

Of course, I could add the closing costs to the loan’s principal, which my loan specialist suggested. Since I wanted to reduce my total debt, I wasn’t happy with this option.

I was peeved at paying high closing costs, since they don’t give me a bigger equity stake and have little tangible benefit. Paying $1,000 or less to refinance a mortgage is fairer.

Besides, in an age of massive automation and bank bailouts, closing costs needn’t be that high. My bank can borrow from the Federal Reserve at less than 1 percent and has received $25 billion from taxpayers. It can afford to cut borrowers some slack. I’m shopping around for a better rate and lower costs.

When It Won’t Work

With these low rates, though, only a select group of homeowners should be refinancing.

Are you facing a job transfer or plan to move within a few years? You may not be able to recoup the closing costs or realize those huge long-term interest savings. And if you don’t have much equity in the home (less than 20 percent) or below- average credit, you may pay a higher rate or not qualify at all.

What if you plan to stay for a while?

Should you consider a 15- or 20-year loan to pay it off earlier and save on total interest?

While the rates on these mortgages would be lower, the monthly payments would be higher than 30-year notes. And there would still be those nagging closing costs.

One thing that my broker didn’t pitch was a way to pay off the loan earlier without refinancing. That would save me thousands in interest costs -- without having to pay a dime of onerous closing fees.

It’s simple: Prepay principal with every monthly payment.

Hidden Truth

You could effectively turn your existing 6.25 percent, 30- year note into a 20-year mortgage by applying an extra $350 a month to principal.

Over the life of the loan, you would save almost $140,000 in interest payments alone. Even paying an additional $208.50 would save $100,000 in total interest.

If you don’t care about building equity or paying off the loan, focus on lower payments and recouping the closing costs.

Since the Federal Reserve is subsidizing these low rates by buying as much as $1.25 trillion in securities from the government-seized mortgage entities Freddie Mac and Fannie Mae, they will not last.

Market forces, inflation or a new government policy will eventually force rates up. The Fed’s purchasing is slated to end in the first quarter of next year.

Clearly this is one situation in which patience probably isn’t a virtue.

(John F. Wasik, author of “The Audacity of Help: Obama’s Economic Plan and the Remaking of America,” is a Bloomberg News columnist. The opinions expressed are his own.)

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