Understanding When to Refinance

Why Refinance?
There are lots of reasons you might want to refinance, but most people fit into one (or more) of the basic four catagories. Most people want to reduce their monthly payments; some want to consolidate outstanding debt, such as combining a first and second mortgage into a new first mortgage; some want to tap built-up equity in their homes, and some just want to get out of a mortgage product that they don't like, or that's costing too much -- going from an ARM to a fixed rate mortgage, for example.

Whatever group or groups you fit with, there are certain rules that you must follow to reach the goal desired. Straying from some of these basics can end up not only costing time, but could end up costing more money in the future.

2% Rule of Thumb?
The traditional refinance rule of thumb -- that you must get an interest rate at least 2% below the interest rate you currently have -- is often wrong. Why? Waiting for a two percent difference from your rate to show up in the marketplace can actually cost you money. For some people, as little as one-half of one percent can be enough, if all other factors fall into place. In addition, since ARMs are priced at below-market rates, it's almost always possible to get that 2% spread -- though you may or may not want to. The only way to determine whether refinancing is for you is to go about it the right way: by analyzing the time and the cost factors.

What Is Your Time Frame?
What is your time frame? Simply put, it's how long you plan on holding this mortgage, although it can be more complicated than that. You might have a product that demands refinancing -- like a balloon mortgage -- your time frame is only until the balloon period runs out. But, if you don't have to refinance, your time frame can be as long as you plan to stay in the home you're in. When determining your time factor, it's crucial to be honest with yourself, since the time factor will determine if and when you begin to save money. It's a fact that refinancing can cost a considerable amount of money, so you'll want to be as certain as possible of your time frame. For example, is it likely that your employer will relocate you to another city, or that you'll change jobs soon? Do you have a physical condition that could require you to move?

Evaluating all possibilities is vital, but only you know what your time frame will be.

More or Less Mortgage?
One other factor involved in refinancing your mortgage: how much money you'll need or want to borrow. Most lenders will let you borrow around 80% of your home's current appraised value. Some will allow more, if you're simply refinancing your existing loan. But, if you're looking to tap equity, known in the mortgage industry as a 'cash-out refi', you'll probably find that it's less than 80%. In many cases, cashing-out will mean that you'll have a larger mortgage balance than before, with possibly a higher monthly payment -- and you'll have to qualify for that new mortgage.

Another consideration with a cash-out refi: you might not be able to get that nice low rate you've seen, if your mortgage amount will be above the 'conforming' loan amount. Conforming loans are sold to large secondary market investors -- mostly to Fannie Mae and Freddie Mac -- and since they buy so many, the rates are often lower. However, loans above the conforming limit, known as 'jumbo' loans, often have interest rates as much as 1/2% higher than conforming, since they are bought and sold on a much smaller scale. This is also known as the 'jumbo premium'. In short, if you have to or want to take out a jumbo mortgage, be prepared to pay more for it.

Cash-out Refi or Home Equity Loan?
If freeing up cash in your home is what you'd like to do, there's a way to do so, even without refinancing: taking a home-equity loan. Home equity loans can be a viable alternative to a cash-out refi, although they are not without their own set of risks. Most Home Equity loans are of the adjustable-rate, revolving 'line of credit' type, and work much like a credit card does, and lenders will generally offer you as much as 75% of the equity in your home (the appraised value less the balance of your first mortgage). Most lines are pegged to the Prime rate plus a margin, but be careful -- most don't have per-adjustment interest rate caps, and some have lifetime caps of as much as 25%. There are fixed rate home equity loans available too, and they function much like any first or second mortgage does, but will cost you more than a line of credit.

Closing Costs
Now that we know why you want to refinance, how long you're planning to hold the mortgage, and how much money you want or need to borrow, we can look into possibly the most difficult part: closing costs. Closing costs are what it will cost you, out of pocket, to obtain that new mortgage. Keep in mind, of course, that the more it costs you to get that new loan, the longer it will take to recoup those costs, so there may be some finite limits on what you want to pay.

While some closing costs are standard -- that is, you'll find them all over the country -- there are some that may be specific to your local market, or to your state. Estimating your costs will take a little research, but it's important because they'll cost you anywhere between $1000 to $5000 dollars. Along with the time factor, they will determine your savings (or costs) when you refinance.

The major closing cost in obtaining any mortgage are 'points', also known as 'discount' and 'origination' points. Origination points are treated differently for tax purposes, but each point is equal to 1% of the mortgage amount you borrow -- $1000 each if you're borrowing $100,000. How many points you want to pay, or whether you want to pay any at all, depends upon how much cash you have available. Typically, paying more 'discount' points will lower the available interest rate, since they are a prepayment of interest; however, you may not know that points can often be traded off for a different interest rate -- such as 9% and 3 points, 9.125% and 2 points, 9.25% and 1 point, and 9.375% and no points. (This is just an example).

So, if you decide that paying points is not for you, expect to pay an incrementally higher interest rate. Origination points are a different matter, since they technically are a fee, and they have no effect whatsoever on the interest rate you can obtain. (Some states limit the number of discount points a lender can charge in the making of a mortgage loan).

Of course, points (discount or otherwise) are only one of the costs involved with refinancing. As you well remember from getting your original mortgage, there are plenty of others waiting to tap your resources -- costs for appraising your property, researching your title to the property, title insurance, credit checks, attorney review fees, inspections for insects, and others. These can easily add up to a few thousand dollars, but there may be ways you can reduce these costs. For example, if the lender who originated your mortgage still holds it, you might be able to simply update your title insurance policy, instead of taking out a new one. Or, if your original mortgage required Private Mortgage Insurance (PMI) because you put less than 20% down on the property, and your new mortgage will be 80% or less than the appraised value, you can probably drop your PMI coverage, saving you as much as the equivalent of 1/4 of one percent on your new interest rate. Shopping around and comparing can also help you save on these fees.

One other possible cost, depending upon where you live: taxes. Some states have surcharges known as 'mortgage taxes', 'realty transfer taxes', 'mortgage recording fees' and others. It is very important to find out if your area is one that does charge these fees, since they can add as much as 2% of the mortgage amount to your closing costs, and significantly lengthen the cost recovery time.

What Kind of Mortgage?
Getting the wrong kind of mortgage for your situation, even with a low interest rate, can, and often will, end up costing you money in the long run. Conversely, getting the right kind of mortgage, without a low enough interest rate, can make it take a very long time to recoup your closing costs.

That's because some mortgages are better suited for a shorter time frame, some for mid-length times, and others for the long haul. The time frame you have available will help determine what kinds of products are best suited to your needs. Refinancing to a 30 year fixed rate mortgage may be the wrong selection for you if you don't plan on holding the mortgage long enough to make it pay.

The biggest savings, as you'd expect, come from paying less interest. If you are comfortable with the monthly payment you are now making, it may very well be possible for you to refinance into a mortgage with a shorter term -- 15 or 20 years, for example -- for the very same monthly payment you have now. A 15 year mortgage payment is only about 25% higher than that of a 30 year -- not double, as you might expect. While this won't put money back in your pocket every month, it will let you build equity in your home twice as fast, which can pay you back in a lump sum if and when you sell the home, or let you borrow larger sums against it later. Overall, where a 30 year, $100,000 mortgage (at 10%) will cost you about $216,000 in interest costs over the life of the loan, a 15 year term will only cost you about $94,000 -- a $122,000 savings. So, the term of the loan you want can also help determine your overall savings.

As we mentioned, your time frame will determine the best types of mortgage for you. For example, if your time frame is reasonably short, say one to four years, you'll want to consider a short term mortgage, like a one-year adjustable rate mortgage. With a very low first year's interest rate, and a per-adjustment cap of 2%, you can virtually guarantee that low interest rate, in this example, would be at least 2% below an available 30 year fixed rate, and approximately 3% to 5% below your current interest rate. Don't laugh -- a 4% interest rate spread would recoup $3000 in closing costs in less than one year, plus you'd still have a second year at below market rates. It's certainly worth considering an ARM if your time frame is very short.

As you'd expect, your mortgage choices expand as your time frame does. With a time frame of five to seven years, you might consider a balloon mortgage or the newer "Two-Step" mortgage. With either, your payments are based on as long as thirty years, but your mortgage may end at a much shorter time. But, since your mortgage can end at a shorter time, you get an added benefit: an interest rate that is roughly 1/2% lower than the prevailing 30 year fixed rate mortgage.

If your time frame runs six years or longer, you can start to consider other mortgages, including the 30 year fixed rate; as an alternative, you could also consider taking an ARM, and be prepared to refinance again in another three or four years. This isn't as crazy as it may sound, as we'll show on the chart below by making a worst case assumption. (We assume the same points and closing costs on each mortgage).

Four Year cost analysis: 1 Year ARM vs 30 Year Fixed

$100,000 Original Mortgage Amount

1 Year ARM with 2% Per-Adjustment Cap and 6% Life Caps vs.
30-Year Fixed Rate Mortgage at 9.50%

1 Yr. ARM Mo. Payment Yr. Total
Year 1 6.5% $632.07 $7,584.84
Year 2 8.5% $761.19 $9,134.28
Year 3 10.5% $903.69 $10,837.44
Year 4 12.5% $1054.11 $12,649,33
Grand Totals: $40,205.89
30 Yr. Fixed Mo. Payment Yr. Total
Year 1 9.5% $840.85 $10,090.25
Year 2 9.5% $840.85 $10,090.25
Year 3 9.5% $840.85 $10,090.25
Year 4 9.5% $840.85 $10,090.25
Grand Total: $40,361.00


As you can see, even at a worst case, your 30 year fixed rate would still have cost you slightly more over the four year period. In addition, it's very possible that your ARM wouldn't have gone up the full 2% every year. In that event, if your rate didn't go up the full 2%, year, you would have saved money -- perhaps even enough to pay for your next refinance.

How long will it take for your refinance to save you money? That all depends upon the difference between your existing monthly payment and the monthly payment on your new mortgage.

Breaking Even
Most people want to recoup their closing costs within a "reasonable" amount of time -- typically, three or four years. Of course, lowering your monthly payment (if that's why you refinanced) will put a few dollars back in your pocket every month. Your break-even point (the point where the savings each month has offset the cost of your refi) should be short enough that you enjoy at least a year or two of savings after the break-even point expired.

To start with, you'll need to know what the available interest rates are on the type of mortgage that fits your needs; the difference between your current and projected monthly payments; and your closing costs.

At Alpine Mortgage, we specialize in assisting customers find the right financing that best suits their needs. Apply online today www.alpinemortgagerutherford.com or contact us at 201-935-7777 to have one of our loan specialists assist you with your financing needs.

Mortgage Basics for the First Time Home Buyer

 

What is a Mortgage?
A mortgage is a loan you take out to finance the purchase of your home. It's a legal contract stating that you promise to make a monthly payment until your loan is paid off. Today, there are more than 40,000 lending entities in the United States. Some are very small companies and may originate loans only for people in a particular state. Others are large companies that work with people all over the country.


Mortgage Rates
Think of your mortgage rate as the interest rate, or fee, you're charged to borrow money from your lender. Mortgage rates are tied to a particular economic index. How your mortgage rate moves up or down, or whether it moves at all, will depend upon the mortgage program you select. For example, with a fixed-rate program your interest rate is fixed for the entire term of your loan. In contrast, with an adjustable-rate mortgage, your rate is fixed for a period of time-usually one, three, five or seven years-and then changes based on the index to which it's tied. The rate on your mortgage is expressed as a percentage and interest accumulates over time on the unpaid balance of your loan. Generally speaking, the higher your mortgage rate, the larger your monthly mortgage payment. Keep in mind, however, that unlike the interest you pay on a credit card, the interest you pay on your home loan is usually tax-deductible*. This is one of the reasons that people "roll", or combine, their credit card debt into their mortgage.


Your Credit Matters
While your credit history is certainly not the only factor lenders take into account, it is very important. Your credit report contains a credit risk score, which is an assessment of your credit-worthiness. Credit bureaus provide risk scores to credit grantors who use them to objectively evaluate an applicant's credit-worthiness. You should review your credit report for errors and discrepancies. Bills that have been paid could remain on your credit report and might cause your lender to deny the loan. If you find any inaccuracies, contact each of the three major credit bureaus (Trans Union, Experián and Equifax) to have them cleared from your report.


Fixed-Rate Mortgages
Fixed-rate mortgages have a fixed interest rate over the entire term of the loan and are very popular. Many people like this type of loan because it offers certainty: the interest rate never changes. And, many home buyers believe that a fixed-rate loan is the best way for them to pay off their mortgage.


Adjustable Rate Mortgages (ARM)
Adjustable rate mortgages, or ARMs, are mortgage programs that are fixed for an introductory period (typically one, three, five or seven years), but after the fixed period, the rate adjusts based on a pre-determined index. If the index goes up, so does your interest rate and mortgage payment. Conversely, a drop in the index will reduce your rate and payment. Perhaps the greatest benefit to an ARM is that this type of program usually offers consumers lower initial rates (and therefore, a lower initial monthly mortgage payment) than a comparable fixed-rated mortgage.


Interest-Only Mortgages
Fixed-rate and adjustable rate mortgages sometimes come with the option to pay only the interest for part of the mortgage term. An interest-only mortgage means you are only required to pay the interest portion of the mortgage payment for an initial period of the loan term. After that, you are required to make the principal and interest payment in full every month. For any given month during the interest-only period, the homeowner has the choice whether to pay all of the interest and as much or as little of the principal as he wants. This is very popular because it gives the homeowner the flexibility to allocate their money towards other objectives.


What Mortgage Program Should I Choose?
When selecting a mortgage, it's very important to choose a program that best fits your particular circumstances. Unfortunately, there isn't one program that is best for everyone. A mortgage banker can help you decide which is best for your situation.


Do Your Research
Before you start the mortgage process or house hunting, do some research. The Internet is a wonderful resource for countless informative articles that explain the mortgage process in great detail. In fact, many lenders have online mortgage calculators that will answer a variety of tough questions, including: 1. How much money can I borrow? 2. What is my price range? 3. What tax savings are associated with homeownership?


Applying for a Mortgage
Once upon a time when home buyers applied for home loans, they had to take time off of work to meet their lenders, fill out reams of paperwork, wait days to find out if they'd been approved for a loan and then wait weeks to close. Not anymore! Many lenders now have online tools that allow you to apply for a loan from the comfort of your own home. With new and innovative technology, you even can sign your mortgage documents electronically.


How Do I Find a Reputable Mortgage Banker?
Whether you decide to work with a mortgage banker, credit union or another lending entity, it is crucial to choose a reputable, experienced mortgage professional who is associated with a company that isn't likely to go out of business when rates increase. Since there are thousands of mortgage companies in the United States, selecting a mortgage expert can be challenging. Seek out recommendations from relatives and friends.


At Alpine Mortgage, we specialize in assisting first time home buyers find the right financing that best suits their needs. Contact us at 201-935-7777 to have one of our loan specialists assist you with your first time home purchase.