This HSH Associates publication, originally released as a
12-page booklet entitled "Guidelines: Refinance," has helped many
tens of thousands of people to find the best deal for their
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There are lots of reasons you might want to refinance, but
most people fit into one (or more) of the basic four catagories.
Most people want to reduce their monthly payments; some want to
consolidate outstanding debt, such as combining a first and
second mortgage into a new first mortgage; some want to tap
built-up equity in their homes, and some just want to get out of
a mortgage product that they don't like, or that's costing too
much -- going from an ARM to a fixed rate mortgage, for
Whatever group or groups you fit with, there are certain rules
that you must follow to reach the goal desired. Straying from
some of these basics can end up not only costing time, but could
end up costing more money in the future.
2% Rule of Thumb?
The traditional refinance rule of thumb -- that you must get
an interest rate at least 2% below the interest rate you
currently have -- is often wrong. Why? Waiting for a two percent
difference from your rate to show up in the marketplace can
actually cost you money. For some people, as little as one-half
of one percent can be enough, if all other factors fall into
place. In addition, since ARMs are priced at below-market rates,
it's almost always possible to get that 2% spread -- though you
may or may not want to. The only way to determine whether
refinancing is for you is to go about it the right way: by
analyzing the time and the cost factors.
What Is Your Time Frame?
What is your time frame? Simply put, it's how long you plan on
holding this mortgage, although it can be more complicated than
that. You might have a product that demands refinancing -- like a
balloon mortgage -- your time frame is only until the balloon
period runs out. But, if you don't have to refinance, your time
frame can be as long as you plan to stay in the home you're in.
When determining your time factor, it's crucial to be honest with
yourself, since the time factor will determine if and when you
begin to save money. It's a fact that refinancing can cost a
considerable amount of money, so you'll want to be as certain as
possible of your time frame. For example, is it likely that your
employer will relocate you to another city, or that you'll change
jobs soon? Do you have a physical condition that could require
you to move?
Evaluating all possibilities is vital, but only you know what
your time frame will be.
More or Less Mortgage?
One other factor involved in refinancing your mortgage: how
much money you'll need or want to borrow. Most lenders will let
you borrow around 80% of your home's current appraised value.
Some will allow more, if you're simply refinancing your existing
loan. But, if you're looking to tap equity, known in the mortgage
industry as a 'cash-out refi', you'll probably find that it's
less than 80%. In many cases, cashing-out will mean that you'll
have a larger mortgage balance than before, with possibly a
higher monthly payment -- and you'll have to
for that new mortgage.
Another consideration with a cash-out refi: you might not be
able to get that nice low rate you've seen, if your mortgage
amount will be above the '
' loan amount. Conforming loans are sold to large secondary
market investors -- mostly to Fannie Mae and Freddie Mac -- and
since they buy so many, the rates are often lower. However, loans
above the conforming limit, known as 'jumbo' loans, often have
interest rates as much as 1/2% higher than conforming, since they
are bought and sold on a much smaller scale. This is also known
as the 'jumbo premium'. In short, if you have to or want to take
out a jumbo mortgage, be prepared to pay more for it.
Cash-out Refi or Home Equity Loan?
If freeing up cash in your home is what you'd like to do,
there's a way to do so, even without refinancing: taking a
home-equity loan. Home equity loans can be a viable alternative
to a cash-out refi, although they are not without their own set
of risks. Most Home Equity loans are of the adjustable-rate,
revolving 'line of credit' type, and work much like a credit card
does, and lenders will generally offer you as much as 75% of the
equity in your home (the appraised value less the balance of your
first mortgage). Most lines are pegged to the Prime rate plus a
margin, but be careful --
most don't have per-adjustment interest rate caps
, and some have
lifetime caps of as much as 25%
. There are fixed rate home equity loans available too, and they
function much like any first or second mortgage does, but will
cost you more than a line of credit.
Now that we know why you want to refinance, how long you're
planning to hold the mortgage, and how much money you want or
need to borrow, we can look into possibly the most difficult
part: closing costs. Closing costs are what it will cost you, out
of pocket, to obtain that new mortgage. Keep in mind, of course,
that the more it costs you to get that new loan, the longer it
will take to recoup those costs, so there may be some finite
limits on what you want to pay.
While some closing costs are standard -- that is, you'll find
them all over the country -- there are some that may be specific
to your local market, or to your state. Estimating your costs
will take a little research, but it's important because they'll
cost you anywhere between $1000 to $5000 dollars. Along with the
time factor, they will determine your savings (or costs) when you
The major closing cost in obtaining any mortgage are 'points',
also known as 'discount' and 'origination' points. Origination
points are treated differently for tax purposes, but each point
is equal to 1% of the mortgage amount you borrow -- $1000 each if
you're borrowing $100,000. How many points you want to pay, or
whether you want to pay any at all, depends upon how much cash
you have available. Typically, paying more 'discount' points will
lower the available interest rate, since they are a prepayment of
interest; however, you may not know that points can often be
traded off for a different interest rate -- such as 9% and 3
points, 9.125% and 2 points, 9.25% and 1 point, and 9.375% and no
points. (This is just an example).
So, if you decide that paying points is not for you, expect to
pay an incrementally higher interest rate. Origination points are
a different matter, since they technically are a fee, and they
have no effect whatsoever on the interest rate you can obtain.
(Some states limit the number of discount points a lender can
charge in the making of a mortgage loan).
Of course, points (discount or otherwise) are only one of the
costs involved with refinancing. As you well remember from
getting your original mortgage, there are plenty of others
waiting to tap your resources -- costs for appraising your
property, researching your title to the property, title
insurance, credit checks, attorney review fees, inspections for
insects, and others. These can easily add up to a few thousand
dollars, but there may be ways you can reduce these costs. For
example, if the lender who originated your mortgage still holds
it, you might be able to simply update your title insurance
policy, instead of taking out a new one. Or, if your original
mortgage required Private Mortgage Insurance (PMI) because you
put less than 20% down on the property, and your new mortgage
will be 80% or less than the appraised value, you can probably
drop your PMI coverage, saving you as much as the equivalent of
1/4 of one percent on your new interest rate. Shopping around and
comparing can also help you save on these fees.
One other possible cost, depending upon where you live:
Some states have surcharges known as 'mortgage taxes', 'realty
transfer taxes', 'mortgage recording fees' and others. It is very
important to find out if your area is one that does charge these
fees, since they can add as much as 2% of the mortgage amount to
your closing costs, and significantly lengthen the cost recovery
What Kind of Mortgage?
wrong kind of mortgage
for your situation, even with a low interest rate, can, and often
will, end up costing you money in the long run. Conversely,
getting the right kind of mortgage, without a low enough interest
rate, can make it take a very long time to recoup your closing
That's because some mortgages are better suited for a shorter
time frame, some for mid-length times, and others for the long
haul. The time frame you have available will help determine what
kinds of products are best suited to your needs. Refinancing to a
30 year fixed rate mortgage may be the wrong selection for you if
you don't plan on holding the mortgage long enough to make it
The biggest savings, as you'd expect, come from paying
. If you are comfortable with the monthly payment you are now
making, it may very well be possible for you to refinance into a
mortgage with a shorter term -- 15 or 20 years, for example --
for the very same monthly payment you have now. A 15 year
mortgage payment is only about 25% higher than that of a 30 year
-- not double, as you might expect. While this won't put money
back in your pocket every month, it will let you build equity in
twice as fast
, which can pay you back in a lump sum if and when you sell the
home, or let you borrow larger sums against it later. Overall,
where a 30 year, $100,000 mortgage (at 10%) will cost you about
$216,000 in interest costs over the life of the loan, a 15 year
term will only cost you about $94,000 -- a $122,000 savings. So,
the term of the loan you want can also help determine your
As we mentioned, your time frame will determine the best types
of mortgage for you. For example, if your time frame is
reasonably short, say one to four years, you'll want to consider
a short term mortgage, like a one-year adjustable rate mortgage.
With a very low first year's interest rate, and a per-adjustment
cap of 2%, you can virtually guarantee that low interest rate, in
this example, would be at least 2% below an available 30 year
fixed rate, and approximately 3% to 5% below your current
interest rate. Don't laugh -- a 4% interest rate spread would
recoup $3000 in closing costs in less than one year, plus you'd
still have a second year at below market rates. It's certainly
worth considering an ARM if your time frame is very short.
As you'd expect, your mortgage choices expand as your time
frame does. With a time frame of five to seven years, you might
consider a balloon mortgage or the newer "Two-Step" mortgage.
With either, your payments are based on as long as thirty years,
but your mortgage may end at a much shorter time. But, since your
mortgage can end at a shorter time, you get an added benefit: an
interest rate that is roughly 1/2% lower than the prevailing 30
year fixed rate mortgage.
If your time frame runs six years or longer, you can start to
consider other mortgages, including the 30 year fixed rate; as an
alternative, you could also consider taking an ARM, and be
prepared to refinance again in another three or four years. This
isn't as crazy as it may sound, as we'll show on the chart below
by making a worst case assumption. (We assume the same points and
closing costs on each mortgage).
Four Year cost analysis: 1 Year ARM vs 30 Year Fixed
$100,000 Original Mortgage Amount
1 Year ARM with 2% Per-Adjustment Cap and 6% Life Caps
30-Year Fixed Rate Mortgage at 9.50%
1 Yr. ARM
30 Yr. Fixed
As you can see, even at a worst case, your 30 year fixed rate
would still have cost you slightly more over the four year
period. In addition, it's very possible that your ARM wouldn't
have gone up the full 2% every year. In that event, if your rate
didn't go up the full 2%, year, you would have saved money --
perhaps even enough to pay for your next refinance.
How long will it take for your refinance to save you money?
That all depends upon the difference between your existing
monthly payment and the monthly payment on your new mortgage.
Most people want to recoup their closing costs within a
"reasonable" amount of time -- typically, three or four years. Of
course, lowering your monthly payment (if that's why you
refinanced) will put a few dollars back in your pocket every
month. Your break-even point (the point where the savings each
month has offset the cost of your refi) should be short enough
that you enjoy at least a year or two of savings after the
break-even point expired.
To start with, you'll need to know what the available interest
rates are on the type of mortgage that fits your needs; the
difference between your current and projected monthly payments;
and your closing costs. Using the worksheet below, you can
estimate one (or more) possible scenarios to see just how long it
Time Frame Evaluation: Your Mortgage vs New Mortgage
Your New Mortgage:
|Discount Points (in dollars)
|Origination Points (if any)
|Attorney Review fee (yours)
|Attorney Review fee (lender's)
|Title Search Fee
|Title Insurance Fee
|Inspections (Insects, etc.)
|Local Fees (Taxes, Transfers)
|Add 10% to estimate for misc. costs
|Prepayment Penalty on your mortgage (if
|Total of all fees on your new mortgage:
Comparing the Old with the New
|Your current mortgage's monthly payment
|Your New mortgage's monthly payment
||$_________ (Principal & Interest
|Difference between the two payments:
|Total of all fees, divided by
the difference in monthly payments:
This number is the number of months it will take to recoup
your costs. After this time expires, you'll actually begin to
save money each month.
Finding those low mortgage rates
When you refinance, you'll want to find the best overall terms
available for the type of loan you need. There's a few methods
you can use: call the lenders yourself, research advertisements
in the local newspapers, ask friends to recommend a lender. While
all these work just fine, there's a problem: you still won't know
if a lender's rate is really competitive. But there is another
mortgage-shopping kit for consumers,
Homebuyer's Mortgage Kit.
The Homebuyer's Mortgage Kit can help you decide whether or
not to refinance. You can see what loans are available in your
area, determine the ones you can qualify for, calculate your
monthly payment for each, and then compare against your present
magazine has called the HSH
Homebuyer's Mortgage Kit
"One of the 100 Best Deals in America", because it can literally
tens of thousands of dollars
over the life of your loan.
HSH Associates, Financial Publishers, is the nation's largest
publisher of mortgage information. We do not make, nor do we
broker or arrange mortgages. With a survey base of loan
information from over 2,000 lenders coast-to-coast, HSH provides
surveys and statistics to the nation's consumers, government
agencies, lenders, Realtors and news media, and is widely
recognized for our objective, unbiased reporting on consumer
HSH also conducts regular national surveys on
Home Equity lines of credit,
new and used auto loans, Certificate of Deposit and Money Market
information, as well as other types of consumer information,
satisfaction and customer relations polls. HSH's consumer
products include the Homebuyer's Mortgage Kit, website and a
variety of low-cost booklets.
Calculating Mortgage Payments
Monthly Payments For Each $1000
Principal and Interest Combined
15 Year Term
30 Year Term
For instructions on using this chart, see below.
Calculating Mortgage Payments
The Monthly Mortgage Payment Chart will allow you to estimate
your monthly principal and interest payments for any fixed
interest rate mortgage, including Conventional, FHA (Plan 203b),
VA, Balloon, or Rollover mortgages. You can't reliably use the
chart to calculate the monthly payment for an adjustable-rate
mortgage, except for the initial period; after that, of course,
the rate (and the payments) will be different.
If you have a specific property in mind, you can also estimate
your total monthly payment. To do this, you must know (or
estimate) the following: the real estate tax(es), the property
insurance cost, and, if the property is in a special hazard area
(such as a flood zone), the cost for such insurance.
How To Use The Chart
This chart covers interest rates from 3% to 10.75%, and loan
terms of 15 and 30 years. Each of the term columns shows the
monthly payment (Principal + Interest), and the total amount you
will pay back, for each $1,000 of the loan.
For example: you want to borrow $49,000 at 14% for 30 years.
Scan down the interest rate column until you come to 14%. Follow
this line across the page until you reach the "30 years" column.
Your monthly payment for each $1,000 of the loan will come to
$11.85 (with a grand total paid of $4,266.00). To find your
monthly payment or your total payment, multiply the appropriate
figure times the number of $1,000s in your mortgage. In our
example, with a loan of $49,000, multiply:
Remember, these figures are the loan payment only. For your
total monthly payment, you must add taxes and insurance. Add the
total annual taxes and insurance together, divide the total by
12, and add the result to your monthly payment. This is something
of an approximation, because you have to make these payments to
the lender. The lender, in turn, deposits his money into an
"escrow" account, until the payments are actually made. You will,
however, be close to the actual payment amount.
Copyright © 2005, HSH® Associates. All rights reserved. This
booklet may be copied and distributed, providing that full source
credit is left intact and a link to (or mention of) our Web site
HSH® Associates, Financial Publishers
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