Taking advantage of lower rates

Recent years have seen a boom in the mortgage refinancing market. Thousands of homeowners refinanced their loans in order to lower monthly payments and have more money left at the end of the month. Those who are still contemplating whether or not to take the plunge should know that the decision to refinance should involve more than just reviewing the prevailing interest rates.

The word refinancing can be misleading. It may suggest to many homeowners that their mortgage is being altered or changed in some way. According to the Mortgage Bankers Association of America (MBAA), refinancing simply means taking out a new mortgage, and using the new loan to pay off the previous mortgage. This means that refinancing involves many of the same steps that buyers had to go through to get their mortgage in the first place. It also means that many of the same costs will be incurred. "There are still plenty of people out there who are trying to decide whether or not to refinance," said Steve Warrington, president of Warrington Mortgage in Feasterville. "Many people started the process early in the year but never locked in because they heard that rates were going to drop even lower. When mortgage rates didn't drop as much as they expected, they didn't complete the refinancing process."

It is natural to assume that mortgage rates will drop when the Federal Reserve announces a rate reduction, but in reality the mortgage industry does not always respond to the change. "The Federal Reserve rates don't have as much of an impact on mortgage rates as people may think. Bond traders really dictate the interest rate for mortgages," said Warrington, explaining that the Federal Reserve rates are generally for short-term investments, but mortgages are considered long-term products.

With today's rate for a 0 point, 30-year loan being around 7 percent, those who have not yet refinanced may benefit from such a consideration. Trying to decide if you are a good candidate for such a change can be confusing. The MBAA suggests that, when looking at the different variables involved in refinancing, homeowners should consider how much the loan will cost, how much they can save per month, and how long they plan to stay in their current home.

When it comes to mortgage rates, the rule of thumb suggests that the lower the interest rate, the higher the upfront costs are to obtain the loan. For example, most homeowners know that they can lower their interest rate by paying points. Every point represents 1 percent of the mortgage amount. Three points is the average amount required to buy the interest rate to the lowest that the lending institution has to offer, but 3 percent of any loan amount can be a lot of money to hand over.

Sometimes banks and mortgage companies offer refinancing specials at "no cost." These "specials" may be a good choice when keeping cost down is a major consideration, but homeowners should not expect them to offer the lowest rates available in the marketplace. Most financial institutions will allow borrowers to add the fees to the loan amount, but because the mortgage amount would then be higher the consumer must look at the new monthly payment to determine if he is still saving money.

"When shopping for a loan, people should not just call up different mortgage companies and ask them what their rates are," Warrington said. "They should ask a lot of questions about the fees that are tacked on by the company." Some fees should be expected. Costs such as application, appraisal, and document preparation fees are all part of an average refinance package.

Be wary of companies that offer rates well below the percentages that the industry is quoting. These institutions will probably attempt to make up the difference by adding unnecessary fees. It is also a good idea to get an estimate of closing costs in writing before deciding on enlisting the services of any particular mortgage company.

Talking with a local mortgage professional will help to determine what the new payment would be after refinancing. While the amount of monthly savings is the major contributor to the refinancing decision, there are other factors to consider.

The MBAA suggests that homeowners also talk to their accountant before deciding to refinance. A lower interest rate on a home loan also means the homeowner will have less interest to deduct on his income tax return. That may increase the amount of taxes due and decrease the sum that the refinance is saving overall.

"Homeowners should also look at how long they plan on staying in that particular house," said Warrington. "If they plan on moving in a few years, they may not be there long enough to recoup the cost, and if that happens they really aren't saving any money."

Another reason to refinance an existing loan is to consider other types of mortgages. Homeowners who took an adjustable loan when buying their home may feel more comfortable with a fixed-rate loan. Others may want to reduce their term from 30 to 15 years. Even if the payments are slightly higher, the shorter term demands less interest over the life of the loan and allows the homeowner to build equity more quickly.

When changing programs, homeowners should be careful to ask how long the company is guaranteeing the interest rate for the new loan. Allowing the rate to "float" can mean that it will change daily. To eliminate any surprises on the date of closing the loan, consumers may choose to "lock-in" the rate directly after deciding on the financial institution. Most lenders require some of the closing cost to be paid in advance when choosing this option.

Another way to make refinancing work to the benefit of the homeowner is to tap into the equity of the home. When consumers refinance for more than the balance remaining on the old mortgage, they walk away with extra cash. Although their monthly payments will be higher than they were previously, the refinance is still a good move if they are using the cash to pay off any higher-rate loans they may have. Using the remaining cash for home improvements or repairs can be another wise investment choice.

The MBAA warns those prone to frivolous spending that the "extra cash" option may not be to their best benefit. Using the money to pay off credit cards may be optimal in the beginning, but a homeowner can get into serious financial trouble by running the bills up again soon after.

Defaulting on a mortgage can result in the loss of a home, so homeowners should always be aware of their debt load and their ability to repay.

Related links:

1. Higher refi fees ahead
2. Owners see homes as best place to invest
3. What you should consider before refinancing loan