Refinance Considerations
When you’re making your decision, there are several things to keep in mind.
If your current interest rate is significantly higher than today’s lowest rates, you may be able to roll your loan costs into the loan and still get a lower rate than you have today, thereby reducing your interest payments and saving money immediately.
Second, if you are planning to stay in your home for at least three to five years, it may make sense to pay “points” (a point equals 1% of the loan amount) and closing costs to get the lowest available rate.
And third, you can avoid laying out cash and still get a low rate by adding the points and closing costs to your new mortgage. Does that mean shouldering a lot of extra debt? Not necessarily. If you’ve had your current mortgage for at least three years, you’ve probably reduced your balance by several thousand dollars. So you may be able to tack your closing costs onto your new loan and still end up with a mortgage that’s smaller than your original one — plus, of course, a lower rate and lower monthly payment.
Get Your Hands on Some Cash
Another way to make a refinance work for you is to refinance for more than the balance remaining on your old mortgage — in effect, tapping your home equity, or “cashing out,” in mortgage lingo. Thanks to favorable rates, you may be able to do so without boosting your monthly outlay. For example, at 8.5%, the payment on a $200,000, 30-year fixed rate mortgage is $1,538. But at 7.5%, that same payment lets you borrow nearly $20,000 more.
The best use for the extra cash is to pay off any higher rate loans you may have. Let’s say that you are carrying a $15,000 car loan at 10% and making minimum payments on a $10,000 credit card balance at 17%. Your monthly payments on those debts would total $680. Then assume you refinanced your mortgage, taking out an additional $25,000 to pay off your car and credit card loans. Result: At 7.5%, your additional monthly mortgage payment would total only $175, so you would come out $505 ahead ($680-$175=$505).
Of course, all the extra cash needn’t go for paying off debts. When the Menards swapped their ARM for a fixed rate last December, they also increased their mortgage load by $34,000, from $106,000 to $140,000. They used $3,000 of the proceeds to pay their refinancing costs and another $17,000 to pay off a 10% home equity loan, which had been costing them $250 a month. Then they spent the remaining $14,000 to build a garage for Roger’s antique car collection — and they did all this for just another $19 a month.
Trade Your ARM for a Fixed Rate
By switching to a fixed rate loan, you will not only reduce your payment, you will also likely lock in an attractive rate for as long as you own your home.
In fact, while one year ARMs currently offer tempting introductory rates, most experts recommend avoiding them, because you could easily find yourself facing sharply higher payments in the near future, even if interest rates don’t rise. Why? Well, after the introductory rate expires, ARMs are typically pegged to the one year Treasury rate (recently 5.25%) plus 2.75 percentage points, with increases of as much as two points a year. Assuming interest rates don’t change, you would pay 7.59% in the second year (the full two point increase) and 8% in the third year.
There are certain cases, however, where an ARM makes sense. If you are fairly certain you’ll be moving within five years, you can save some money — and avoid rising payments — with a five year ARM. Such loans offer a fixed rate for five years and adjust annually thereafter.
