In the recent past, banks have tightened their requirements for getting a mortgage and in giving refinances. The reason is simple, the banks earn less on your mortgage if they refinance from a higher rate of interest to a lower interest rate. For example, if your loan is for $100,000 and your loan interest rate is 5% and you refinance to a 4% loan, the bank will earn approximately $19,000 less in interest over the life of loan. Your payment would go from $543 to $477 and the breakeven would be 53 months. This illustration includes fees of $2500 and 1% origination fee (Bank Profit).
Put another way, you will save $19,000 in interest over the next 30 years and after 53 months the lower payment absorbs the fees and points. That looks simple but like any other financial tool, there needs to be a discussion about things that invariably come up when refinancing. These items for consideration include:
1. Points which are expressed as a percent of the loan,
2. Fees which include escrow, transactions, recordation, and legal,
3. Appraisal charges
4. More equity requirement
5. Home valuation/market valuation
Points, fees, and appraisal costs are usually miniscule compared to the “More down” requirement and effect of home values on a refi. Nevertheless, consider the costs going into a refi as part of the decision whether to go forward.
Banks have been putting up roadblocks to refinancing by changing the percent required down, and this amount can be large. In some cases it can ruin the idea of refinancing since it can exhaust your savings/reserves all to appease the bank’s higher equity requirement. Take into consideration declining real estate values and you may be required to come up with thousands of dollars to make the deal work. Even then, the bank will drag their feet, since you are paying them more interest while you go through the refinance process.
My rules for refinancing are:
1. Consider refinancing if rates drop 1% or more,
2. Do not use all of your reserves to accommodate your lender, consider competitors,
3. Look closely at “deals” offered by lenders, the fees can diminish the advantages of refinancing so read the small print,
4. Consider the monthly payment and the costs of the refinance, not just the monthly payment, and
5. Consider that if you have paid 5 years on the mortgage and whether going to a new 30-year mortgage is worth the loss of those 5 years, older teachers near retirement may wish to stay the course and pay off the mortgage as planned.
If you have questions, post on the blog for A Teacher’s Pocket Guide to Finance. Be patient and you will enjoy the ride, especially when refinancing your home.