When Does It Make Sense to Refinance?

SANTA ANA, CA, May 21, 2012 (MARKETWIRE via COMTEX) --
While most people usually think of real estate "affordability" in terms of buying a home, the concept also applies to refinancing. Rate reductions may cut monthly costs and the overall expense of ownership, making a home more affordable. The big question: When is the right time to refinance?

"Many borrowers have the opportunity to reduce mortgage payments at a time when expenses such as gas and healthcare are rising," said Ray Brousseau, executive vice president of Carrington Mortgage Services, a lender in the District of Columbia. "In addition, many people who lacked sufficient equity to refinance may now be able to get a replacement mortgage because of changes in the government's HARP program."

( http://www.firstcapitalmtg.com/ ) provides information regarding a wide variety of FHA, VA and conventional loans. "It pays to watch the changes to these programs," "For instance, the government has greatly reduced mortgage insurance premiums for borrowers who refinance older FHA loans. Some FHA borrowers may be able to cut their rate significantly, plus reduce their annual mortgage insurance premium by $1,000 or more, according to government estimates. These are major discounts for most households."

In mid-April, mortgage rates across the country were near 4 percent for a 30-year fixed-rate loan while Adjustable Rate Mortgage (ARM) start rates were less than 3 percent. Such rates are significantly below the levels now paid by many homeowners.
Monthly Savings
To see the benefits of refinancing consider the following example:

        
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           Balance            Rate           Payment
           Amount     Term    (%)    (Principal & Interest)   Lifetime Interest Cost
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          Original
            Loan
        ----------------------------------------------------------------------------
          $150,000     30      6            $899/mo.                 $173,759
        ----------------------------------------------------------------------------
          $150,000     30      4            $716/mo.                 $107,803
        ----------------------------------------------------------------------------
           After 6
            Years
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          $137,000     30      4            $654/mo.                 $98,461
        ----------------------------------------------------------------------------
          $137,000     15     3.5           $979/mo.                 $39,290
        ----------------------------------------------------------------------------
          

The monthly savings are clear for a rate reduction from 6 to 4 percent. Taxes and insurance are extra.
Borrowers also need to consider the age and the length of the mortgage. Over time you will owe less than the original balance. In the table above, after six years, you will owe about $137,000. Refinancing reduces the payment to $654 per month, but the term of the loan is extended to 30 years again, meaning that the borrower will make an extra six years of payments over the term of the loan.

If the original loan is an ARM the comparison will be different. ARM rates can rise and fall, making refinancing to a fixed-rate mortgage an attractive option for those who prefer to lock-in today's historically low interest rates and have payment stability.

Is Now the Time To Refinance?

Going to a lower rate is a very good reason to refinance, but how much lower should the new rate be to justify the costs of refinancing? There's no "official rule" says Brousseau, but the new loan should produce a clear benefit to the borrower in terms of lower monthly payments or reduced interest costs, but you must also consider the costs of refinancing.

For example, imagine that refinancing will require $4,000 for taxes, closing and other expenses. If a borrower can save $150 a month with a lower rate loan, it will then take approximately 27 months to break even. If the borrower expects to remain in the home for a period longer than 27 months, then refinancing becomes attractive.

But some refinancings can be structured with little or no out-of-pocket costs. Instead, the borrower might accept a slightly higher interest rate to eliminate closing costs.

"There's a lot of flexibility built into the mortgage system, with combinations of rates and terms that offer different benefits," says Brousseau. "The trick is to assess your individual situation and pick the option that works best in your circumstances.

Financial Engineering One of the important aspects of refinancing is that you can engineer the loan to provide the type of benefit which is most important to you. For most people the goal is to have lower monthly costs but that's not always the case.

"The usual alternative to a 30-year loan is a 15-year mortgage," said Brousseau. "Such financing generally has a higher monthly principal and interest payment than a 30-year loan but a lower overall interest expense over the term of the loan. Some borrowers prefer a 15-year loan because it means they can pay off their mortgage much faster. That can be important when looking ahead toward retirement or facing new costs in the future such as college tuition."
"In effect it's a form of savings plan," said Brousseau. "By having a mortgage with a shorter term you can significantly reduce your overall financing costs."

In the example above, the borrower could reduce his or her monthly principal and interest payments from $899 to $654 by refinancing. That's a monthly savings of $245 or $2,940 per year. If that same $137,000 loan is refinanced over 15 years instead of 30 years, lenders have less risk of non-payment and will generally offer a lower rate. If the 15-year rate is 3.5 percent, the new monthly payment will be $979.

If the 15-year loan is more expensive on a monthly basis than the current 30-year mortgage, why would anyone refinance their loan to assume a bigger monthly payment? The answer lies in the interest paid during the full term of the loan.

The $150,000 loan at 6 percent over 30 years has a potential lifetime interest cost of $173,759. A 15-year loan has 180 fewer payments. The $137,000 replacement mortgage at a fixed interest rate of 3.5 percent over 15 years has a potential interest cost of approximately $39,290. That's a savings in this example of more than $134,000 -- almost as much as the loan amount being refinanced.

"It's all about savings and options," says Brousseau. "When homeowners examine the numbers, it's hard to beat the rates and refinancing opportunities which are now available."

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