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November 4, 2002
"What questions about refinancing are
asked most frequently?"
The most common question by far is
"should I refinance". Usually I can�t answer it because questioners
don�t give me all the needed information. If borrowers are looking solely to
reduce costs and not to raise cash, I refer them to calculator 3a on my web site
if they have one mortgage, and to 3b if they have two. These calculators answer
the question, "will refinancing reduce my total financing cost?"
The calculators force potential questioners
to collect the information that affects the decision. Once they have it, they
only need to enter it into the calculator, as I would do, to get the answer --
so they don�t need me.
"With interest rates so low, why isn�t
the refinance decision a slam dunk?"
Sometimes it is. If a borrower with a 7% loan
is offered a 6% loan with no refinance costs, the decision of whether or not to
refinance is a slam-dunk; the deal will clearly leave the borrower better off.
But that doesn�t necessarily mean there isn�t
a better deal out there. Nor does it mean that the borrower couldn�t lower the new rate even
more by paying the refinance costs. Neither of
these issues is a slam-dunk.
"When is no-cost refinance the right way
to go?"
When you are sure to have the mortgage for
less than 3-4 years. You either plan to sell the house within that period, or
you are convinced that interest rates will fall further and you will refinance
again.
If you expect to have the mortgage more than
3-4 years, paying the refinance costs in exchange for a lower interest rate is
the way to go. You can find the exact break-even period for yourself using my
calculators 11a or 11b.
"Do you shop your current lender
first?"
No, last.
The advantage of refinancing with your
current lender is that he can usually cut some settlement costs out of the deal,
and in some cases, can lower the interest rate without refinancing. The
disadvantage is that your current lender is not motivated to give you the best
deal, or the best service, because you are already a client.
You need to change your lender�s mindset in
that regard. The way to do that is to find a good deal elsewhere, then notify
your lender that you are refinancing. Then you select the better deal. Just make
sure you compare them on the same day.
"How does making extra payments affect
the decision to refinance?"
Ignore extra payments made in the past, that�s
water over the dam. Looking ahead, if you are torn between repaying your loan in
full or refinancing, consider repayment first. Repayment is an investment on
which the yield is the rate at which you could refinance. [If you can refinance
your current loan at 6%, for example, you earn 6% by paying it off.] Compare
this to the returns on your investment alternatives. If you repay in full, that�s
it.
If you don�t repay in full, consider the
benefit of refinancing. If you plan to make extra payments in the future, you
factor these plans into your analysis. In using my refinance calculators, you do
that by shortening the remaining term of your new mortgage. If you plan to
refinance into a 15-year loan, for example, but extra payments would result in
payoff in 10 years, you use 10 years as the term. You can determine the payoff
period from any extra payments using my calculator 2a.
"How is the refinance decision affected
if I want to take cash out of the transaction?"
If the main objective is to take out cash,
the issue is no longer whether refinancing will lower costs. The issue is
whether the cost of raising cash using a cash-out refinance is higher or lower
than raising cash using a second mortgage. [A cash-out refinance is one for an
amount in excess of the loan balance plus settlement costs].
A cash-out refi with an interest rate below
the existing rate is likely to be less costly than a second mortgage. If the
cash-out refi rate is higher than the existing rate, the second mortgage is
likely to be cheaper, even though the second mortgage rate may be well above the
cash-out refi rate. The reason is that the second mortgage allows the borrower
to retain the lower rate on the existing mortgage.
But don�t depend on generalizations.
Calculator 3d gives a precise answer. If you use the cash to consolidate
existing debt, use calculators 1b or 1c.
Copyright Jack Guttentag 2002
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