Refinancing Isn't for Everyone
Eric Gillin
03/29/02 - 07:43 AM EST
As mortgage rates rise, the refinancing rush will wane. But with rates still near 7%, below the historical average of 8%, homeowners eager to tap their equity should act quickly, although not hastily.
While refinancing works for those making home improvements, consolidating debts or reducing loan costs, it's not right for everyone. Homeowners who are deep in their loan periods or who don't plan to stay long in their current homes, for instance, should think twice about refinancing.
Three factors come into play when considering refinancing: the interest rate, how much it costs to refinance and the homeowner's time frame. As a rule, the bigger differential there is between your current rate and the refinance rate, the shorter time it will take to recoup the cost of refinancing.
"It's not a matter of merely getting to the break-even point," says Keith Gumbinger, vice president at mortgage-tracker HSH Associates. "The point of refinancing is ultimately to save some money."
Assess Yourself
Because refinancing is a laborious process, homeowners should know why they're doing it and understand the alternatives. After spending weeks putting together an application, many discover that they end up saving little. "If it costs you $2,000 to refinance, and 36 months down the road, you have just saved $380, it might not be worth your while," Gumbinger says.
Start by looking at your mortgage rate. Unless you can save at least 1 full percentage point, refinancing offers little benefit because you're pushing off equity payments and adding in refinancing costs.
"A full point is really a good number," says Richard Bloom, a certified financial planner with Bloom Asset Management in Farmington Hills, Mich. "But don't do it just for cash flow, because you've increased debt load and have to pay it off down the road."
Homeowners with lower balances need to be especially cautious because they'll need a bigger rate differential to recoup costs. In order to save $99 each month on a $575,000 loan at 8%, for example, you would need to refinance at 7.75%. But to save that same amount on a $125,000 loan at 8%, you would need to refinance at 7.25%.
Recouping Costs
The longer you stay in a home, the more likely you are to recoup refinancing costs. This means you could wind up saving nothing if you move within a few years. "You should be able to save enough money to cover your costs in 10 months and stay for more than two years," says David Kasprisin, vice president and loan manager, National City Mortgage Services.
Let's say you've already paid five years on a 30-year fixed-rate mortgage of $125,000 at 8%. You refinance the $120,000 left to pay with a 30-year fixed-rate mortgage at 7.25%. Fees on the new loan will run you $3,000 and create a new loan balance of $174,000. While monthly payments are $100 less, it would take you about 2 1/2 years to cover the cost of the loan.
Homeowners also should think twice before refinancing late in the game. By that point, you're accumulating equity, and refinancing will only restart the amortization process. "Once you've passed about seven years or more, you probably aren't a candidate to refinance in a traditional fashion," Gumbinger says.
For example: After paying 10 years on a 30-year fixed-rate mortgage of $200,000 at 8%, you will have paid $152,000. Refinancing the loan balance of $177,000 at 7.25% would lower monthly payments by $260, but creates a new loan balance of $258,000. By maturity, you've paid $410,000 on both loans. "You just made yourself a 40-year mortgage," Kasprisin says.
If you had done nothing, you would have paid just $329,000 -- and in 10 fewer years.
Lower Payments, but Higher Costs
Lower monthly mortgage payments can be alluring, but while you pay less now, you can end up paying more later. Unless you're using the increase in cash flow to fix your finances, refinancing won't save you much, especially if you keep spending.
"Every refinance should be looked at as an opportunity to shorten the maturity, not lower the monthly payment," says Randy Johnson, author of
How to Save Thousands of Dollars on Your Home Mortgage.
And reducing home equity can cause some serious problems, because that's the share you'll receive when you decide to sell. In a sense, you're stealing from yourself, leaving less for the down payment on the next place. As a result, homeowners can inadvertently trap themselves when proceeds from the sale can't cover the down payment and other costs associated with buying a new house.
Also, if you've taken out more than 80% of your home's value, you may have to pay private mortgage insurance, or PMI, depending on how your mortgage is structured. This can add thousands of dollars in costs.
Don't Give in to Peer Pressure
Just because the neighbors are refinancing, lenders keep calling and ads are packing your mailbox doesn't mean you're missing out. Check into refinancing, but don't succumb to peer pressure. "Some fairly bright people make mistakes," Johnson says.
Carefully examine what the lender offers to make sure those fabulous lower monthly payments don't hurt you in the long run. Ask questions if transaction costs are high because unless you have shoddy credit, a better deal might be found elsewhere. And "don't refinance if you get the feeling from a lender that they're not being honest," Kasprisin says.
The bottom line: Refinancing isn't right for everyone, so find a reputable lender to help you examine your specific situation. Anyone can become a mortgage loan officer because lenders don't need a license to sell you a mortgage. Some see only dollar signs when you walk in the door and don't always give the best advice.
"It gives the industry a black eye because [customers are] not getting conscientious advice," says Kasprisin. "Lenders are just happy to have someone on the phone."
