Mortgage interest rates are at their lowest rates in about two years. In 1993, the 30-year fixed rate loan dropped to under 7 percent, and a few lucky souls in October managed to nail down a fixed interest rate of 6.75 percent.
While we’re not quite there yet, we’re within spitting distance. That has led to a second refinancing boom.
With so much interest in the mortgage market, now is a good time to cover the basics on refinancing:
Q: When should I refinance?
If you’re within the first five years of your loan, you should consider refinancing if you can lower your interest rate enough to cover the costs of the refinancing within a short period of time, say 12 to 18 months.
Home loans are structured so that you pay most of the interest owed in the front portion of the loan. Once you’ve gone past the first five or seven years of a 30-year fixed-rate loan, you’ve paid a significant chunk of your interest.
For example, on a 30-year fixed rate loan of $100,000, carrying an interest rate of 8 percent, after five years (on payment 60), you’ll have built up equity of $4,930 but will have paid $39,095 in interest, with a principal balance of $95,070 left. After ten years (on payment 120), your equity balance will have jumped to $12,274, while you’ll have paid $75,776 in interest with a principal balance of $87,725 left over.
If you refinance after five or ten years, you’ll start the clock at zero again, and may never end up building the kind of equity you’re hoping for. On the other hand, if you’re five or ten years into your loan, and you’re carrying an interest rate that’s two or more points higher than the current rates, you might be well advised to refinance. If you plunk the savings into pre-paying your mortgage, you’ll build up equity quickly.
If your interest rate is 9 percent on a 30-year fixed rate loan, there are some viable options available to you. If you’re only going to stay in the home five years or less, you can refinance your principal balance to a 1-year adjustable rate loan that’s currently less than 6 percent.
If your 9 percent, $100,000 loan cost you $804 per month, and your $100,000, 1-year adjustable rate mortgage (ARM) at 5.75 percent costs you $584 per month, and you throw the extra $220 per month as an extra principal payment, you should pay down your new loan quickly. If you only refinance the remaining principal balance of the loan, you’ll be that much better off.
While a 1-year ARM will rise after the first year, you can always refinance with a no-point, no-fee loan. A Michigan homeowner did this successfully for the entire 7 years he owned his home and never paid more than 6 percent in interest.
Q: Interest rates are really low. Should I get a 15-year loan or a 30-year loan?
A: The difference in interest paid between a 15-year loan and a 30-year loan is astronomical. As Marc Eisenson, author of “The Banker’s Secret”, likes to say, getting a 30-year loan is like buying three houses — two of which go to your banker.
On our 30-year, $100,000 loan, you’ll pay $164,160 in interest, for an interest and principal total of $264,000 over the life of your loan. On a 15-year, $100,000 loan at 8 percent, you’ll only pay $72,017 in interest, or $172,017 over the life of your loan. At the same interest rate, you’ll save $90,000 over the life of your loan (and be done that much sooner) by going with a 15-year loan. Here’s an unexpected bonus: You’ll pay a lower interest rate on a 15-year loan. So if you 30-year fixed rate loan is 8 percent, the 15-year version might only be 7.75 percent, so you’re saving even more.
Q: What about a bi-weekly mortgage?
A bi-weekly mortgage is set up so that you’re required to make 26 payments a year, one every other week, or the equivalent of a 13th mortgage payment. This will effectively cut your 30-year loan to about 16 years, saving you almost the same amount of money as a 15-year mortgage.
However, the companies that set up the bi-weekly mortgage will charge you $400-500 to do so. Why pay them the money when you can do the same thing yourself? Most lenders will be happy to set up an electronic withdrawal system from your checking or savings account, and many can do it twice a month as easily as once a month. If your lender will only do an electronic withdrawal once a month, you can make the extra payment each year yourself by writing a check. Either way, you’ll accomplish the same thing without paying extra for it.
Q: Are no-point, no-fee loans really a good idea?
A: If you’re looking to refinance, a no-point, no-fee loan can be a great way to go because you won’t have any out of pocket costs and will start saving immediately. So even if you’ll only lower your interest rate three-quarters of a point, if that’s with a no-point, no-fee loan, you’re saving from day one.
The trick here is to get a no-point, “no fee” loan. Lenders will sometimes give you a no-point loan, and then try to get you to pay fees. Shop around for the best deal.
Q: What other options do I have?
A: If refinancing seems too much to tackle, but you want to lower your interest rate, call up the lender holding your note and tell them you are going to refinance elsewhere unless they lower your rate.
This often works, because the lender doesn’t want to lose you as a customer. They will simply lower the rate on your loan (though perhaps not quite as much as you could get on the open market), and then send you a few papers to sign.
On the other hand, you can just leave your home loan alone, and slowly turn green with envy as your friends and neighbors congratulate themselves on refinancing with some of the lowest rates in a generation.