Posted on: Sunday, May 27, 2001
Best time for refinancing may be now
USA Today
As throngs of homeowners who have refinanced lately can attest, low interest rates and soaring home values can provide powerful financial benefits. It couldn't come at a better time for investors stung by stock market losses the past year.
Mortgage interest rates appear to have bottomed in March, but rates haven't bumped up much. Housing economists expect stability for months to come. So there are still good reasons to consider refinancing. Among them: • Cheap borrowing. You can tap home equity by refinancing for more than what you owe now, taking the difference in cash. Or you can keep your mortgage and get a home-equity loan or line of credit. Interest rates vary depending on which you choose.
Either way, it's a good deal. Because mortgage interest is tax deductible, a nominal borrowing rate of 7.5 percent would be about 5.4 percent after taxes for someone in the 28 percent tax bracket. • Investment flexibility. Buy time to wait for the stock market to recover. Rather than selling that stock or mutual fund at a fire-sale price next time you need cash, you can borrow against home equity.
A home-equity loan also can be a handy source of capital for diversifying a securities portfolio. The trick is to find an investment with reasonable prospects for returning more than you're spending to borrow against your house. • Reduced monthly expenses. Increased home equity means you can roll several debts into one refinanced mortgage at a reduced monthly payment.
And the higher equity that comes from rising home values is allowing some homeowners to shed private mortgage insurance, which kicks in when a home buyer makes an initial down payment of less than 20 percent of the purchase price.
Economic conditions — rising home values, low mortgage interest rates and a scary stock market — create opportunity for smart financial plays. Then again, the wrong move could set you back.
The stock market has rallied in recent weeks, but the carnage from the last year has left even the most optimistic investors queasy. Big losses taken on once-promising stocks have many wondering if their house, which has been gaining value nicely, might not be a better place for their money.
So why not pull back from your stock investing plan and use the money to pay off your mortgage quicker?
In addition to eliminating your house payment earlier, accelerated payments save a huge amount of interest. Example: An extra house payment each year on a $200,000 mortgage at 7.5 percent will save $76,000 in interest payments. It'll also reduce by 30 years to 23 years the time needed to retire the loan.
Nancy Flint-Budde, a certified financial planner in Clifton Park, N.Y., said most people are better off not accelerating their mortgage pay-off schedule if it means altering their normal saving pattern.
Consider: • Retirement. Never accelerate mortgage payments until you've provided for retirement savings, she said. It's important to take advantage of employer-sponsored plans that provide a match. • Liquidity. The extra spending needed to achieve free-and-clear home ownership could squeeze your budget so hard that it could just force additional borrowing in the future. • Taxes. Eliminate your mortgage, and you'll pay a higher percentage of your income in taxes due to the loss of the interest deduction.
People itching to retire and feeling a need to minimize future expenses may be well-advised to accelerate their mortgage payments, Flint-Budde said. But again, not if it means cutting back contributions to retirement accounts.
One last thought: Your mortgage lender may offer to convert you to biweekly mortgage payments — for a fee of several hundred dollars. Don't do it. You accomplish exactly the same thing with no fee by making a 13th monthly payment each year. Plus, the 13-yearly-payments plan doesn't lock you permanently into an accelerated payment schedule.
When the Federal Reserve Board cuts short-term interest rates, as it has five times this year, the phones at mortgage companies ring off the hook. Homeowners want to refinance mortgages at the better rate they believe the Fed cut will cause.
Trouble is, they're already too late. The bond market determines interest on fixed-rate mortgages. Bond traders anticipate Fed rate-cutting and factor it into bond prices long before the actual event.
Borrowers who jump to respond to Fed actions aren't getting burned too badly now, though. Long-term interest rates have been remarkably stable, moving in a narrow range of about a quarter-percentage point since January.
"It's like the stock market," Wells Fargo Home Mortgage's Greg Gwizdz said of mortgage shopping. "You're not always going to buy at the low."
According to mortgage investment giant Freddie Mac, the average fixed rate on a 30-year mortgage last week was 7.14 percent. That's up a few ticks from the 2001 low of 6.89 percent. But keep in mind that the current rate isn't all that much higher than Freddie Mac's 30-year low of 6.49 percent in October 1998.
But borrowers can't judge a refinancing deal strictly by interest rates. The cost of the transaction matters, too. If those costs go above 2 percent of the amount to be borrowed, the deal is probably too expensive. And if you plan to move before recouping refinancing costs through lower payments, it's probably best to stick with your current mortgage.
Motives for refinancing vary: lowering the interest rate, switching from a variable to a fixed interest rate or consolidating debts while lowering monthly payments. But lenders say that the real steam powering the current refinancing boom is a desire to tap rapidly building equity. According to Freddie Mac, 50 percent of refinances through March 31 were "cash-out" transactions, meaning that the borrowers took more money than they needed just to pay off their old mortgage.
A cash-out refinance will give most people seeking to tap equity their best deal, experts say. At the same time, they're not for everybody. For example, a second mortgage is the best route for someone who already has a mortgage at a very low interest rate.
Doug Perry of Countrywide Home Loans said second mortgages can be initiated more cheaply than a first mortgage. Many lenders offer them for free, recovering costs through slightly higher interest rates.
Second mortgages come in two varieties. • Equity line of credit. The lender gives you the right to draw against the equity in the house by writing checks up to the predetermined limit. A typical deal would be structured to give the borrower a draw period of 10 years, with repayment in 25 years.
Equity lines of credit typically are priced in relation to banks' prime rates. A borrower with good credit and plenty of home equity may get the money at the prime rate. A poorer risk who leverages home equity to the maximum may pay up to 3 percentage points more than prime. Lenders might offer a below-prime teaser rate to attract borrowers.
The prime rate rises or falls with the Fed's actions on short-term rates and is now 7.5 percent, or 2 points lower than it was a year ago. • Equity loan. This is a straight second mortgage with the proceeds from the lender coming up front. Among other things, equity loans can help a borrower sidestep expensive private mortgage insurance by keeping the first mortgage below 80 percent of the home value. Typically, equity loans carry a fixed interest rate that runs about 2 percentage points higher than a first mortgage would. Now, a good credit risk can expect to get one for a little more than 9 percent.
Adjustable-rate mortgages are getting little respect these days, but for some they can still be a good deal.
A pure ARM carries an interest rate that adjusts each year. Hybrid ARMs give the borrower an initial fixed rate for an extended period — typically three, five, or seven years — before adjusting on an annual basis. For the initial period, borrowers can count on an interest rate somewhere below the rate for a fixed-rate mortgage.
According to the Mortgage Bankers Association of America, just 8 percent of applications last week sought an ARM. During periods of very high fixed mortgage rates, ARMs have accounted for as much as half of home loans.
Opting to lock in a fixed rate these days is the smart choice because of the low rates. But ARMs, too, are cheap. According to Freddie Mac, the average one-year ARM this week has an interest rate of 6.0 percent, down a full point from December 2000.
Borrowers who could benefit from low ARM rates: • Short-timers who expect to sell the house before the first rate adjustment hits. • First-time or move-up home buyers stretching their finances to get into the house of their dreams.
Recent Fed actions could mean a break for current ARM holders. Rate changes for many ARMs are calculated by adding 2.75 percentage points to the 1-year Treasury bill yield index. Fed rate cuts have indirectly driven down the index. The adjusted rate on the typical ARM — called the fully indexed rate — is likely to be 7 percent or less. That gives ARM holders another year at a moderate interest rate to consider their next mortgage move.
