The Independent Investor: Homeowners: Time to Refinance

By Bill Schmick
iBerkshires Columnist
08:48PM / Thursday, April 30, 2009

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Bill Schmick

If you haven't done so already, it may be time to call your local bank or financial institution and start filling out the paperwork. Mortgage interest rates are at historic lows as housing prices continue to fall and homeowners are refinancing at a higher rate than anytime since 2003.

The trigger for this rush to refinance is the precipitous drop in the average rate for a 30-year, fixed-rate mortgage, which is now just 4.73 percent. Yes, rates could fall further but I advise you not to bet on that since short-term interest rates are approaching zero. At the same time, home prices continue to fall, registering an 18.6 percent drop overall in February.

But the housing numbers in February revealed a silver lining: about half the nation's markets are falling at a slower rate (unfortunately, for New York residents the declines were worse than the previous month but not so in Massachusetts). Many economists predict that prices will drop an additional 10 percent before we reach a bottom. But in some markets, like the state of Florida, where the housing boom went way beyond the national average, steeper declines are expected. That downward price pressure should help keep rates low at least for now.

Much of the credit for lower mortgage rates and aid to the housing markets must go to the Obama administration and its series of programs initiated over the last several months. First-time homebuyers are starting to put their money down thanks to the government's $7,000 tax credit incentive. Over the last month, two first-timers in my office alone bought homes in Clifton Park, N.Y., and Cheshire. I suspect there will be many more such buyers in our region.

If your existing mortgage interest rate is at least one percent higher than the present 4.73 percent rate you might want to explore the possibilities of refinancing, if your mortgage rate is 2 percent or higher than that rate than refinancing should be a no brainer. Ditto for anyone with an adjustable rate mortgage, negative amortization or interest-only loan that is due to reset or which isn't building equity in your home. You might argue that adjustable rate mortgages are even lower right now so why not refinance into an ARM?

I'm a big believer in fixed-rate mortgages. Since most home loans are for 15 to 30 years, with that many years of payments ahead of you the risk that rates will rise is huge, especially since we are at record lows right now. It makes little sense to gamble with an ARM if you can nail down a fixed rate mortgage under 5 percent.

For those who have at least 20 percent equity in your home, another reason to refinance may be the reduction or elimination of the Private Mortgage Insurance (PMI) that you are paying monthly. PMI is a kind of insurance that is required when a buyer can't put the initial 20 percent down required by most lenders on an original home loan. Refinancing could save you anywhere from $70 to $150 or more a month plus the interest savings.

However, be aware that the typical refi will cost you $2,000 or more plus fees. For some, regardless of the rate, it may not make sense to refinance. Those who are planning to move within the next few years should not refinance. The same applies for anyone who plans to pay off their loan in the next three to five years. This is because as a rule of thumb, when you refinance you should look for a payback period within two to three years of the costs you have incurred.

Naturally, for those of us who have a 10-, 20- or 30-year mortgage, the interest you save in refinancing over the life of the loan can be a very large number. Clearly, if you are having a tough time meeting your monthly mortgage payments refinancing will provide relief in paying the bills. But remember mortgage interest is deductible form your income taxes so paying less in monthly payments will normally mean paying slightly higher taxes. For those of us who are more fortunate and who can afford it consider refinancing but shorten the life of the loan at the same time. That way you pay down the loan much faster, take a larger tax deduction and in 15 years (rather than say 30) you own your home free and clear. 

Whatever you decide, I suggest you at least crunch the numbers to see if in your case refinancing makes sense. There are several automatic refinancing programs you can find on the Internet that will do the calculations for you. Trust me, it is well worth your time and effort and who knows, it might end up saving you a pile of cash over the next decade or so. 

Bill Schmick is a registered investment adviser representative and portfolio strategist. Direct your inquiries to Bill at 1-518-610-1553 or e-mail him at wschmick@fairpoint.net. You can also visit www.afewdollarsmore.com for more of Bill's insights

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