by Bryan Lane Berson, Esq.
Download PDF: Refinancing Mortgages
A. Why Do Borrowers Refinance?
When you refinance a mortgage, you replace your current mortgage with a new one that has a different interest rate, maturity, or both. People refinance for a variety of reasons. They may want to
– reduce their interest rate or monthly payments
– borrow money against their equity (i.e., a “cash-out”)
– consolidate their debts or
– convert from an adjustable rate to a fixed rate mortgage.
B. What Should I Be Considering?
Whether you should refinance depends on the circumstances. It may be worthwhile if
– you plan to own your home for the next several years
– the interest rate on the new mortgage is lower than the rate you on your current mortgage and other debts and
– the closing costs are reasonable.
A general rule of thumb says that a borrower should refinance when rates fall 2% or more below the rate you are currently paying. Now, Internet mortgage calculators enable borrowers to perform a more nuanced analysis. They calculate monthly payments based on different terms thereby allowing you to compare the payments.
If your prospective lender has processed your new mortgage application, you will receive a Good Faith Estimate of Settlement Charges (GFE) that estimates your closing costs. If you divide the estimated closing costs by your expected savings per month, you will estimate the number of months required to break even on the refinance.
C. How Much Does it Cost?
There are several different costs. Some lenders charge points. A point is a percentage of the loan. One point is 1% of a loan’s principal. For example, if you borrow $100,000 and pay 1 point, you pay $1,000. It is prepaid interest. Sometimes, it is called a “discount point” because by paying interest up front, you can reduce (discount) your interest rate. Usually, paying a point will reduce your interest rate by ¼ point. If you are paying points and each point doesn’t reduce your interest rate by ¼ point, then you aren’t getting a discount.
Fees should be listed on the GFE. An “origination fee” is calculated like a point is – as a percentage of the loan. For example, if you borrow $100,000 and pay an origination fee of 1%, you pay $1,000. Other fees pay for services or products or are administrative.
The difference between your interest rate and your annual percentage rate (APR) reflects the fees you will pay. The APR will be slightly higher than the rate is. If you compare loans with the same terms, the loan with the lower APR has lower fees.
D. How Does Consolidation Work?
When you consolidate loans, you take several outstanding debts and finance them with a single loan (e.g., mortgage, auto loan, credit card balances).
By consolidating, you may reduce your overall payments per month while lengthening the payback period. If have 25 years left on your current mortgage and 3 years left on a car loan, and you consolidate, you may pay off the new mortgage over 30 years. Effectively, 29 years from now, you will be paying interest on a car that has long since been in the junk yard. As long as there is no prepayment fee, you may consider trying to pay off the new loan by voluntarily paying more towards the principal each month.
Credit cards may be accruing interest at exorbitant rates. If you consolidate them to pay them off at the lower mortgage rate, you should consider canceling credit cards. It may be prudent to keep one credit card for emergencies, but it should have a very modest credit limit, and you should try to not carry a balance. Otherwise, you risk running up your credit cards bills again and compounding your interest and problems.
E. Can I Really Skip the Next Payment (or Two)?
Some lenders advertise that “you can skip the next payment” (or two). Actually, you don’t really skip payments. Here is what is happening.
When you rent an apartment, you pay rent in advance of the month that you lease the premises. For example, you pay the August rent at the beginning of August. In contrast, when you pay a mortgage, you pay it in arrears (i.e., at the end of the month). For example, you pay the August principal and interest at the end of August.
If you refinance on August 15, with regard to the original mortgage, you would not have paid for August yet (because you pay at the end of the month). You new lender may let you “roll” your August payment (and September payment) into your new mortgage. While it feels like you aren’t paying for August and September, you are borrowing those payments and begin repaying them with interest in October.
F. Conclusion
Refinancing is a significant transaction, and you have to make some important decisions. Consider it carefully, and if you decide to refinance, I can help.
About the Author: Bryan L. Berson, Esq. is an attorney and mediator at The Berson Firm, P.C., a law firm that handles estate administration and planning, real estate, commercial transactions, and commercial litigation. His e-mail is bberson@bersonfirm.com. His phone number is (631) 517-1055. Connect with The Berson Firm on Facebook and Bryan L. Berson on LinkedIn. The firm’s website is www.bersonfirm.com.
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