Refinancing an Old Mortgage: Can You Save?

The lowest interest rates in years have not yet spurred consumers to run out, borrow money and spend. But there is one area where the lower rates are causing change: the refinancing of home loans.

Refinancing activity is at a fever pitch as homeowners rush to trade in their old mortgages for new, cheaper ones. Since this time last year, refinancings have jumped 230%, said Richard Teach, deputy chief economist at the Mortgage Bankers Assn. of America in Washington. Just since July, refinancings are up 80%.

Mortgage rates have been declining rapidly. On Wednesday, the Veteran’s Administration lowered its fixed-rate mortgage to 8.5% from 9%, said Larry Caird, a VA spokesman. That’s the lowest rate since April, 1987.

Nationwide, private lender rates are also at a five-year low. The average 30-year fixed-rate mortgage, which cost upward of 10% a year ago, now goes for about 9%, said Keith T. Gumbinger, a spokesman for HSH Associates, a Butler, N.J.-based firm that tracks interest rates.

And, since the Federal Reserve cut a key interest rate last week, some are speculating that rates will fall further. Gumbinger predicts that mortgage rates will hit the lowest levels since 1978 by the end of the week.

That should heat up the refinance market even more, he said. But although homeowners are saving money by refinancing their mortgages, they seem to be using those savings to wring the excesses of the 1980s out of their lives--by paying off credit card debt instead of buying cars or installing swimming pools.

Some lenders are encouraging refinancing by advertising “no point� loans. The Veterans Administration says it is even contemplating a consumer information campaign to urge holders of old VA mortgages to consider refinancing. Some veterans have loans at 12% and 15% rates, Caird said, and refinancing could save them huge amounts each month.

Industry experts stress caution, however, to those contemplating a new note. There are a number of costs associated with taking out a new loan, including credit application fees, title report fees, appraisal costs, fees for inspections and, perhaps, mortgage insurance. Most lenders also charge “points,� usually prepaid interest. In the end, the average homeowner spends 1% to 3% of their loan amount on closing costs, industry experts say.

“Most lenders make sure that the borrower doesn’t incur any out-of-pocket expenses by wrapping the fees into the balance of the loan,� said Teach, “but these costs are very real and consumers need to balance out the costs with their potential savings. That’s not easy to do.�

To calculate when and if it makes sense to refinance a home, consumers need to look at several things: the difference between the old loan rate and current market rates, the amount of equity in the property and how long they plan to live there.

If you put down less than 20% when you bought the house, or if your house has decreased in value, you may have difficulty refinancing. Although it is possible to secure loans for more than 90% of the home’s value, you usually pay for your low equity in higher loan rates and mortgage insurance costs. In some cases, it isn’t worth the bother.

Additionally, those who expect to sell homes in the next few years may be best served by sticking with their current mortgages and avoid all the up-front costs associated with refinancing, industry experts say.

“We’ve had people tell us they lost money by refinancing,� Gumbinger said.

To come out ahead by refinancing, the rule of thumb is to secure a new rate that is two percentage points lower than the current one. That isn’t always the case, however.

Those who plan to stay in their homes for long periods might save money by refinancing when market rates are merely 1% lower than they are already paying. Others might want to exchange adjustable-rate mortgages for fixed-rate notes--even if the cost disparity is slight--to get the stability of set monthly payments.

Those who plan to sell their homes within a few years would need to get a much larger interest-rate break before refinancing would make sense.

To do a thorough analysis of when it is advisable to refinance, you might want to talk to a tax or financial adviser. He or she can determine how particular deals will affect your monthly payments and tax liability.

With a little time and a pocket calculator, you can do a simple analysis of the costs and benefits yourself. Here’s how: Compare current market rates to your loan rate and calculate the difference in monthly payments by referring to an amortization table. (You can usually find one at a public library or at your local bank or thrift, or use the accompanying chart.)

Then find out about all the fees and costs that go with that refinancing--prepayment fees, taxes and transfer fees, title search, insurance, credit check charges and the like. (HSH suggests you add 10% to this cost estimate, for incidental fees that you might forget to ask about.)

Then divide the costs by the amount you would save on each monthly payment to determine how long it will take to break even. (Add a few months to the total to account for the difference in federal taxes, because you will lose part of your mortgage-interest deduction when your interest payment is lower.)

If you plan to stay in the house much beyond the break-even date, refinancing may be just the ticket. If you think you might be moving before then, you should probably stick with your current loan.

For example, if you had a $150,000, 11% fixed-rate loan, your monthly payments would be about $1,429. If you refinanced that loan at 9%, your payments would fall to about $1,207--a $222 monthly savings.

Assuming that you had to pay 2% of the loan amount in points and related fees, you would need to stay in the home at least 14 months to break even--before accounting for any changes in your income tax rate. (The 2%, or $3,000, divided by the monthly payment, $222, is 13.51 months.) So even if you planned to stay in your current residence only for two or three more years, this deal might make sense.

If your rate would fall only by half a percentage point, however, the picture changes. Let’s say your $150,000 loan was at 9.5% and you want to refinance to get a 9% rate. Your monthly payments would drop by about $54, from about $1,261 to $1,207. Using the same cost estimates, it would take nearly five years to break even. If you moved before then, you’d lose money.

Interest Rate free Fall

Average interest rates for home mortgages have dropped dramatically for more than a year, and have remained below 10% since last November. In fact, for the first time in almost five years, private lenders are reportedly asking less than 9% for conventional 30-year fixed mortgages. A look at the most recent months available for fixed-rate and adjustable mortgages. Source: HSH Associates, Butler, N.J.

Refiguring Your Mortage Payments

To decide if it’s smart to refinance your mortgage, figure what your monthly payment will be at the new low interest rates using the following table and instructions.

1. Take your total mortgage and divide it by 1,000. For example, if your mortgage is $150,000, your number to calculate with is 150.

2. Find your current interest rate on the chart.

3. Slide over to the column marked “factor� that applies to your loan. If your mortgage is a 30-year and your interest rate is 10.5%, the factor you need to figure out your payment is 9.15.

4. Multiply 150 (for the mortgage) by 9.15. Your current monthly payment is $1372.50

5. Do the same for the rate at which you could refinance. If your mortgage is $150,000 and you can refinance at 8.75%, multiply 150 by 7.87. The monthly payment at that rate is $1180.50. Refinancing would save you $192 each month.

Interest Rate Factor for Factor for (in percent) 15-Yr. Term 30-Yr. Term 8.00 9.56 7.34 8.25 9.70 7.51 8.50 9.85 7.69 8.75 9.99 7.87 9.00 10.14 8.05 9.25 10.29 8.23 9.50 10.44 8.41 9.75 10.59 8.59 10.00 10.75 8.78 10.25 10.90 8.97 10.50 11.06 9.15 10.75 11.21 9.34 11.00 11.37 9.53 11.25 11.53 9.72 11.50 11.69 9.91 11.75 11.85 10.10 12.00 12.01 10.29 12.25 12.17 10.48 12.50 12.33 10.68 12.75 12.49 10.87 13.00 12.66 11.07 13.25 12.82 11.26 13.50 12.99 11.46 13.75 13.15 11.66

Source: HSH Associates, Butler, N.J.