To Refinance or Not to Refinance-Help!!!

lisonwalFebruary 7, 2009

Does it make sense to refinance based on the circumstances below? My husband and I are debating on this issue. What do you think?

Here are the facts:

* We puchased our house for $168,000 6 years ago at 7% interest rate, 30 yrs

* Our montly payment at that time was in the low $1400s.

* We refinanced 1 year later. Our new balance became 176,000 after refinancing with an interest rate of 6.5%. Our monthly payments was lowered to $1290 but over the years has since gone up to $1392 (insurance and tax increase).

*So to sum up, today our new balance is $156,000 and our monthly payment is now $1392 at 6.5% interest rate

Now, if we refinance,we will have an interest rate of 5% and our payments will be about $1150 a month.

My husband says lets do it because we will now have an extra $150 to $200 each month and a lower interest rate.

I'm concerned because our new balance will go right back up again with another 30 years to pay off the mortgage.

Which is a more beneficial-saving the extra $150 a month with a 1.5% lower interest rate or focusing on lowering the balance of the mortgage?

I'm still a novice at this so any good advice is appreciated!

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dave_donhoff

Hi Lisonwal,

Now, if we refinance,we will have an interest rate of 5% and our payments will be about $1150 a month.

NICE!

My husband says lets do it because we will now have an extra $150 to $200 each month and a lower interest rate.

Smart guy, good catch!

I'm concerned because our new balance will go right back up again with another 30 years to pay off the mortgage.

How will your loan balance go up (other than closing costs)?

As for how many years to pay it off, you're "looking at the big picture through a drinking straw."

1) You aren't constrained to ONLY the minimum loan payments, so you can always pay it off faster if that really makes the best sense,

2) the safest way to eliminate your mortgage debt is to seperately accumulate a side-fund of cash that is larger than it... rather than trying to sliver-it-away while starving your safety reserves and retirement growth funds of that amount of cash.

Which is a more beneficial-saving the extra $150 a month with a 1.5% lower interest rate or focusing on lowering the balance of the mortgage?

Let's flip it around to help with the "obvious" answer;

If I offered to INCREASE your rate 1.5%, and in return force you to pay more of your cash each month into your irretrievable real estate equity balance... would you say 'yes'?

Yahh... I didn't think so either ;~)

NOW... if you are REALLY smart (and also strong in managing your money,) you might *REALLY* find it advisable to move some portion of your personal equity out of the real estate balance and INTO tax-free retirement growth accounts.

Of course, in order to get comfortable with this, you'll have to wrap your head around total costs versus total growth, including your tax planning.

Cheers,
Dave Donhoff
Leverage Planner

    Bookmark   February 7, 2009 at 7:40PM
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lisonwal

Thanks for the advice, Dave, and the laughs, too. I was a bit concerned especially since we will be expected to pay 7500,00 in closing costs. I just didn't see the benefit there.

    Bookmark   February 8, 2009 at 12:24PM
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kec01

Seven thousand, five hundred dollars in closing costs????

If that's what you've been presented with, you are getting royally scr..wed.

We're refinancing right now and our closing costs are $1000. Our neighbors are refinancing with zero closing costs.

    Bookmark   February 9, 2009 at 5:28AM
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quirk

I was thinking the same as kec01; why such high closing costs?

    Bookmark   February 9, 2009 at 9:43AM
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dave_donhoff

Kec & Quirk,

Lisonwal mentioned "$7,500 in closing costs"... but you need be aware of several things;

Prepaid items (escrowed deposits for property taxes, and hazard insurance) add to the "cash required to close" but are not actual costs. The deposits they are replacing from the previous lender's servicing department are refunded generally within 3-6 weeks.

NONETHELESS... many non-financial people look at their "bottom line" of their GFE and think "oh my God, that's "closing costs" ".

NEXT;
Lisonwal hasn't told what the buydown costs are for the interest rate they have locked. At a 5% coupon, depending on their loan-to-value, the loan size itself, their credit, and other factors, they may have a fairly sizable buydown included in their "closing costs." This is definitely not particularly a BAD thing, as it may have a breakeven point in their interest savings at a fairly short period.

AGAIN;
Taking a 30 FRM at "no points" or even "no costs" (when such a thing was actually available) is the MOST expensive money you can borrow, and hardly conservative in most cases.

LASTLY;
In the current mortgage meltdown environment, the back-end bond buyers are refusing to buy loans at enough of a mark-up for the lending banks to advance ALL the cash costs of the transaction itself. The bond buyers are offering a maximum of about 1.5% of a closed loan, while the actual costs run about 3-5%, with a cash minimum around $3,500+.

Because of this the "no cost loans" of the past are... in the past. Folks who have sufficient equity to have their closing costs financed are still able to do so... but there are no "free" mortgages (beside the obvious TANSTAAFL reality.)

Besides... lender-paid loans only made sense when rates still had the potential to drop lower... so taking the inflated higner interest rates that were offered in order to have the bank pay all the cash costs was something people would do on a speculative basis.

No longer is it financially intelligent nor realistic to take a higher interest rate (simply in order to get it for "free") with the argument that you are saving yourself the ability to once again refinance when rates drop in the future.

Cheers,
Dave Donhoff
Leverage Planner

    Bookmark   February 9, 2009 at 1:58PM
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vdinli

Not the OP,but DH and I are pondering a similar question.
Would it be worthwhile to refinance a ~350k mortgage at 6.5% at the current rates of 5-5.25%
Dave, could you elaborate on this point you made.

Dave: Taking a 30 FRM at "no points" or even "no costs" (when such a thing was actually available) is the MOST expensive money you can borrow, and hardly conservative in most cases.
Our understanding is that its worthwhile paying points if you can recoup the costs within the years you are likely to remain in the house. Wouldn't it depend on what the cost of the point and the interest rate drop? I am not understanding why it would be the most expensive money! Sorry, if its a dumb question.

I would love to live where the closing costs are only a 1000$-we are looking at 10K+. No escrow costs, just title insurance and other bank costs! Yeah, Long Island is expensive but this is too much!!

Thanks in advance
Vinaya

    Bookmark   February 10, 2009 at 4:49PM
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dave_donhoff

Hi Vinaya,

Our understanding is that its worthwhile paying points if you can recoup the costs within the years you are likely to remain in the house. Wouldn't it depend on what the cost of the point and the interest rate drop? I am not understanding why it would be the most expensive money! Sorry, if its a dumb question.

*SMART* question... not dumb at all!!!!

You are precisely correct... each incremental "buy down dollar" does not necessarily gain the same "interest savings" and it is important in your analysis to find the "sweet spot" where you buydown (which is basically prepaid non-refundable interest) gets you the best "bang for your buck."

The ratio of savings-to-buydown-costs is generally the strongest at or near "par" (the point where there are no point costs nor rebate at that interest rate,) however it is NOT even & consistent as it proceeds.

To over-dramatize it as an example;
If 6% is "par"....
5.75% might cost 1%
5.5% might cost 2.5 points
5.25% might cost 2.75 points.
5.0% might cost 3.875 points

In this dramatic example, you can see that the 2.75 points for 5.25% rate is better than the "cheaper" points of 2.5% buying 5.5% in rate.

Hope that illuminates the need for the analysis.

Cheers,
Dave Donhoff
Leverage Planner

    Bookmark   February 10, 2009 at 8:43PM
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vdinli

Thanks, Dave. I think I understand it much better. I agree we have to crunch numbers and figure out if its worthwhile! The tough part is that the "spread" of points vs rate keeps changing. I know you have said before the solution to that is to hunt for the "perfect" person not the "rate". We are still looking for that person!!

    Bookmark   February 11, 2009 at 2:46PM
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