Q: Ilyce, please help. Our lender (a big national bank) said they can help us refinance. We’d get an $82,000 home loan, at 3.25 percent interest with no closing costs. The interest rate is tied to the prime rate. Our payments would be $389 a month and we can pay more if we like as long as we keep the loan with them for 2 years. They told us if the prime rate goes up, we can lock in a rate before it rises too much. Is this a good deal?
A: This sounds like a pretty good deal. The best refinance advice I can give you is to be sure to read the fine print so you understand exactly what kind of prepayment penalty you would pay if you have to sell off the house and pay off the mortgage loan within the two year time frame.
You should also understand what financial index the loan is tied to (I know you said the prime rate, but there may be a different index it is tied to when your lender tells you could convert the loan to a fixed rate loan later on) and how quickly your interest rate can rise each year.
For example, variable interest rate loans can typically only rise 1 or 2 percent per year, with a lifetime interest rate cap of 5 or 6 percent. In your case, that would mean your loan would top out at 9.25 percent, no matter how high the prime rate goes.
Finally, while your deal might sound good, you need to understand what your existing loan terms are and how the terms of your new loan compare. What are your savings per month on your new loan when you compare it to your old loan?
Before refinancing, make sure you new loan terms will lower your interest rate. You should also be sure your costs to refinance can be recovered within six months (that is your monthly savings on refinancing your loan will start to benefit you over the costs you pay to refinance within six months). And, be sure you are not extending the length of your loan solely to get the benefit of a lower monthly payment – unless that is the only option available to you. Many homeowners only look at a monthly payment when deciding to refinance a loan. The lower monthly payment is only one piece of the puzzle. If you are going to pay an extra fifteen years of interest to benefit from a lower monthly payment, that would be a bad deal. You might get lot’s of refinance advice and pressure to take a deal, but you need to make sure the refinance is right for you.
If you don’t thoroughly understand what you’re being offered, or all the possible ramifications, please take the time to figure it out before you sign on the dotted line. You can also call a HUD authorized housing counselor. That counselor may also be able to give you additional advice on your refinancing