Refinancing

Many individuals look to refinance not only because of a dire situation but also to take advantage of lower interest rates (to get a free quote click here). The process for refinancing is as follows:

1. You sign a new loan
2. Pay off the old mortgage with the proceeds of the new mortgage
3. Pay the costs of the new loan

These costs, which you are required to pay, increase the cost of your new mortgage. You MUST take this into account when considering if a new mortgage will save you money. Typically, these costs amount to 3% - 6% of the total loan amount. There is a simple way to calculate if these costs will be offset by the lower rates. Divide your closing costs by the difference between your old payments and your new payments. This will show you how long it will take to overcome the refinancing costs.

The general rule: only refinance if the new loan is two percentage points below your old mortgage. This may change depending upon the closing and refinancing costs. The state that you live in may change this amount as well. The reasons for this are the state banking authority's regulations. These regulations govern the prepayment costs and the levels that banks are allowed to charge. Consult your State Banking Authority to learn the specific standards that they have instituted. An example is shown below.

With a mortgage of $60,000 that has a fixed rate of interest of 17%, the monthly payment of principal and interest is $855.41. According to New York laws, the costs of prepaying a mortgage are $783. The upfront fee would be (3% of $60,000) $1,800. This brings the total cost of refinancing to $2,583. If the rates drop to 16%, monthly payments would now be $808.86. Dividing the amount saved per month ($855.41 -$808.86 = $48.55) by the cost of refinancing ($2,583), we see that it takes about 54 months to recoup the cost. On the other hand, if rates drop to 15%, it only takes 27 months.

If you live in California, however, the situation becomes a little trickier. A borrower in California may pay up to 20% of the outstanding balance to the original lender with no penalties. Thus, they can take up to five years to pay off the loan with no penalties. However, if the new mortgage is with another institution, the borrower is required to repay the principal to the original mortgage lender beyond the 20% limit during the first three years. The penalty for this is one-half of the original interest rate applied to the loan's balance. So, if the borrower decided in the second year to repay the $60,000 mortgage at 17%, the prepayment penalty would be $4,080 ($60,000 minus the 20% payment of $12,000 multiplied by 8.5%, which is half of the original 17%). This amount is almost one and a half times that of doing the exact same practice in New York so, BE CAREFUL and know your state laws in regards to refinancing.

Remember: changing interest payments will affect your taxes. With a lower interest rate, your income tax reductions will be reduced. This can decrease your savings with the new mortgage. IRS statutes require you to deduct the refinancing costs over the life of the loan and NOT IN THE FIRST YEAR. Check with the IRS or your accountant to see under which circumstances that this may not apply.

You are also not required to refinance with the same type of mortgage that you originally had. You are simply paying off the original loan and thus are not bound as to what loan you have to take out. The financial conditions and status you have has probably changed since you took out the original loan and therefore, it may be advantageous to you to have another type of loan. For example, you may wish to have fixed loan payments instead of variable payments if the financial markets have dropped interest rates significantly since you took out the original loan (See above example used for refinancing costs).

Note: Get the new terms in writing and make sure you get the total costs you are responsible for, including closing costs.

To get a free quote click here.