Last updated on March 15, 2003
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HOME EQUITY
Full Refinancing
First the good news. An owner who trades a $200,000 fixed-rate, 30-year mortgage at 8%
for the same loan at 6% is happily saving $268 a month before taxes. Refinancing means
paying off your old loan and getting a new first mortgage. Now the bad news. It generally
means paying fees for origination, appraisal and credit check, and points, too. What if your rate is 7.5%, or you paid to refinance a couple of years ago, or you have
an adjustable-rate mortgage (ARM) with an adjustment due soon? Is refinancing worth it?
A home-equity loan may be the fastest way to tap your equity, but refinancing could be
the better route in any of the following situations:
- Interest rates are 2% or more less than what you are now paying.
- Rates aren't quite 2% less, but you plan to stay put.
- You figure you could pay off a new loan in less time with roughly the same payment you
are making on your current mortgage.
Do you have remodeling in mind? Say your home is worth $200,000 and the mortgage
balance is $155,000. You could refinance for $175,000 at a new lower rate, use $155,000 to
pay off the old loan and free $20,000 of home equity for remodeling. Lower interest rates
mean you could get a bigger loan without a big increase in monthly payments. For example,
the principal and interest payment on a $200,000, 9%, 30-year, fixed-rate mortgage is
$1,609. With rates at 6%, if you refinanced for $230,000 and used the money left after
paying off the old loan for home improvements, monthly principal and interest payments on
the new loan would be $1,379. That's a monthly savings of $230 and you have $30,000 to improve your property.
Refinancing can make sense even if you don't need to tap the equity in your home.
Consider refinancing anytime there's a difference of two percentage points or more
between your fixed-loan rate and current rates. The two-point rule works in your favor
when you stay in the house long enough for lower monthly payments to offset the costs of
refinancing -- usually several years. Refinancing with less than a two-point differential
can be advantageous if you plan to live in your home for a long time. Even a 1.5-point
spread can do the trick when you stick around more than seven years. Use the Am I better off refinancing? calculator to crunch your own numbers.
What about ARMs?
The problem with ARMs is that your current rate probably is below today's 30-year
fixed rate. Should you keep it, trade to a fixed rate or take advantage of low teaser
rates on new ARMs?
Switching to a fixed rate. If you plan to stay in your house, it could
make sense to lock in a fixed rate. You wouldn't necessarily save a lot of money
compared with the ARM you trade in, but you'd have peace of mind knowing your rates won't rise.
An ARM for an ARM. When first year "teaser" rates are two to
three percentage points lower than your current ARM, it's tempting to consider
switching an old ARM for a new one. First-year payments would drop substantially. But
after that, the interest rate would reach about what it would have been on your old ARM,
assuming the index and margin were the same. You come out ahead only if your first-year
savings exceed the cost of refinancing.
Switching from a fixed-rate to an ARM. If you plan to sell within one
to three years, you could cut your monthly principal and interest payments dramatically by
switching to an ARM.
Tax concerns
When you're refinancing just the balance of your mortgage, interest on the entire
amount is tax-deductible. If you borrow additional money, the interest on up to $100,000
extra is deductible as home-equity debt.
Unlike points for the original mortgage, points for refinancing must be deducted over
the life of the loan, whether you pay in cash or add them to the loan, unless you use the
funds for improvements to your home. If you use all additional funds from the refinancing
for home improvements, you can deduct all interest payments on the loan and the full
amount of the points related to the improvement.
You can keep money in your pocket by folding the closing costs into the loan. This also
has the effect of adding otherwise nondeductible charges, such as an appraisal fee, to the
amount on which you pay deductible interest.
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IN THIS TUTORIAL
Full Refinancing
