Refinancing Pros and Cons

Question: We owe about $155,000.00 on a 30 year, 8% mortgage that is 7 years old. We are in the 35% tax bracket, but plan to "move" within the next five years. Does it make sense to refinance our home mortgage?

If so, should it be for 15 or 30 years, or should we attempt to pay off the mortgage principal? Please advise. The process of home mortgage refinancing is confusing to us and seems to be fraught with uncertainty and financial risk.

Answer: Currently, mortgage interest rates are in the 6 to 6-1/4% range, depending on the number of mortgage points that you pay. Oversimplified, each mortgage point is the equivalent of approximately 1/8th of a percent on a mortgage. Thus, you could get a 6-1/4% rate with no mortgage points, but if you pay 2 mortgage points, you may be able to get a 6-00% rate.

You indicate that you have only 23 years left to pay on your current home mortgage. However, you are paying what is now clearly too high a mortgage rate of interest, and I strongly recommend that you give serious thought to refinancing your existing home mortgage.

No one wants to extend their mortgage debt. Thus, the temptation would be to substitute a new home mortgage (refinance) for a 15-year term period, which would be roughly equivalent to the remaining time left on your current home mortgage.

In any discussion of mortgages and home mortgage refinancing, one has to sit down and "do the numbers." Let’s look at some typical mortgage refinance examples based on your situation.

Unfortunately, when a person refinances their existing home mortgage, there will be mortgage closing costs involved. A new title search has to be accomplished, a survey has to be obtained (if it is not a condominium), and various lender and recording charges have to be paid. Roughly, these mortgage costs will range (including the payment of mortgage points) between $1,000-$2,500.

Since you currently owe $55,000.00, and presumably your house is worth considerably more than that, I would recommend that you include these costs into your new mortgage refinance, rather than pay the settlement costs out of your own pocket. Thus, let us assume that you will be refinancing for a new home mortgage of approximately $58,000.

If you could obtain a 7-1/2%, zero mortgage point 30-year mortgage, the monthly payment of principal and interest will be $405.55. If you were to get a 15-year mortgage, in most cases lenders will charge you a little lower rate of interest. Thus, the monthly principal and interest payment for a 15-year mortgage at 7 % would be $521.33. For purposes of this discussion, we are not including any escrows for taxes or insurance in the calculations.

The difference between the 30 year mortgage payment and the 15 year mortgage payment is $115.78 a month, or $1389.36 per year.

Even though the monthly home mortgage refinance payments on a new 15-year mortgage will probably be less than you are currently paying on your 9% home mortgage, I always recommend you take a serious look at a 15-year home mortgage.

Another option is to refinance to a 30-year period if if there are no mortgage prepayment penalties. You could then, for example, add the $115.78 to your monthly mortgage payment each month and essentially get the same benefit of a 15-year home mortgage, without having the obligation to make those higher monthly mortgage payments.

There is a very dramatic decline if you make an extra mortgage principal payment each month, for example, on a 30-year fixed rate home mortgage. If you make 13 monthly payment per year (i.e., one extra monthly payment), you could, in most cases, payoff your loan in 22 years. Indeed, if you were so inclined, you could even make larger mortgage payments on your home mortgage so as to reduce the home mortgage even less than 15 years.

You may also consider obtaining a home equity loan, either at the time you refinance or shortly thereafter. A home equity loan or home equity line of credit permits you to keep a checkbook in your desk drawer, and you pay interest only on the monies that you actually borrow. This is an opportunity to tap your equity when you need it, without having to go through the lengthy and time-consuming process of obtaining yet another home mortgage. Keep in mind that when you retire, you probably will not be able to obtain a new home mortgage, unless your income is still strong.

Thus, a home equity loan is the equivalent of putting your equity in the bank without having to pay any interest until you need the money.

You should understand, however, that a home equity loan is a second deed of trust (mortgage) on your home and you could lose your valuable asset if you are not careful.

You also asked whether you would get a low rate mortgage from the mortgage company currently servicing your home mortgage, or should you shop around. My advice to everyone is always shop around.

Contact your current mortgage lender, and contact several other mortgage lenders as well. In today’s marketplace, mortgage lenders often sell their home mortgages. The mortgage lender that made your original home mortgage may no longer be in business. Your current mortgage lender may only be an out of state servicer, and not at all interested in assisting you with mortgage refinancing. But clearly you must shop around to obtain the lowest mortgage rate and terms.

For more helpful mortgage tips on mortgage refinancing, home mortgages, reverse mortgages or a home equity line of credit, contact FreeLoanComparison.com today!

Last update: November 14, 2008