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Refinance Refresher
In mid-January, Mortgage rates for conventional loans up to Fannie's new $275,000 limit fell briefly to a two-year low, about 6.875%% without discount points or origination fee -- commonly known as "zero plus zero" terms -- and then rebounded to 7.25%.
(Note: rates as of January 13, 2001. The Fed's half-point easing has NOT helped, nor likely will further easing at the end of this month; as always, new releases of economic data can quickly change mortgage rates.)
As rates may once again dip into the sixes, herewith a refresher course -- not a technical manual, but a kind of checklist for those who may not be especially money savvy, or who don't have a free week to shop and get up to conceptual speed, but also don't want to leave extra money on the closing table.
First. Beware the interest rates in the news media, which rely on national surveys, most of which understate rates because they erroneously assume borrowers always pay an "origination fee." Also, all national surveys suffer from time lag, survey to publication. Ask a lender you trust to tell you where rates really are; if you haven't got one you trust, test a few lenders against the concepts below.
Second. Do not try to predict the future of interest rates, and don't let tales of possible future drops cloud your judgment into indecision. Refinancing windows may stay open for months (as one did in 1993), but more often they close quickly.
The current window opened just before Christmas, and few have noticed – in part because of miserable reporting in the media. Worse, the media are now beginning another mistaken drumbeat: "The-Fed's-easing-and-rates-are-going-lower." Mortgage rates often reach a low before the Fed begins to ease: presumably the easing will succeed in stimulating the economy, and when it does, there is no reason for mortgage rates to be so low.
Mortgage rates are not going a lot lower unless the economy turns out to be sinking faster than anyone thinks – no matter how easy the Fed gets.
Third. If you are still determined to predict the course of interest rates, predict the past. Several times in the 1990's mortgage rates reached 7.00-7.50% territory, rebounding each time. Only once in the last thirty-five years have mortgage rates broken the 7.00% barrier on "zero plus zero" terms... for two months in 1998... just before the Fed began to ease. Tend to take any rate close to seven, and don't fish for bottom.
Fourth. As the future is impossible to know, take any refi deal in which the interest savings after tax will recapture the closing costs (which are not deductible) within a reasonable time relative to how long you think you will own your home. (If your lender can't deliver an after-tax estimate... find another lender.)
As rates have had a habit of dropping to the low sevens every couple of years, avoid refis which have a cost-recapture period longer than two years – even if you think you'll live in the home forever.
Fifth. When calling mortgage retailers, the quickest way to identify a quack or an operator: if he or she suggests you pay an "origination fee" to get a lower rate. Just say "thank you", and put the phone down quietly, backing away as you would to avoid a nut at the mall. Under the best of circumstances, an origination fee (or any amount of discount points, which are the same as an origination fee) will take more than five years to recapture through slightly lower monthly payments.
A refinance is not the best of circumstances: origination and discount in a refi are tax-deductible pro rata over the life of the new loan, not in the year of the refinance. Depending on your tax bracket and how you run the math, it will take most consumers eight or more years to recover these fees.
Sixth. The next best quack detector: any retailer who wants you to focus on savings in your monthly payment, as opposed to true interest savings. When you refinance from an old loan to a new 30-year one, you add time to the amortization, which produces the illusion of saving money.
Example: a $200,000 30-year loan at 8.25% has monthly payments of $1,502. Let's suppose you've made payments for two years: the remaining balance is $196,685. If you stretch that balance back out to thirty years at the same 8.25%, your payment will drop to $1,478 per month... "saving" you twenty-four bucks a month. When the decision to go or not go with a refi rests on savings seldom more than $100 per month, amortization trickery can often tip you into a deal that wasn't quite worth doing.
Seventh. As refi closing costs change little with the size of the loan, the larger your loan, the less drop in rate you need to justify a refinance. If you've got a "jumbo" loan (bigger than $275,000), call your last retailer whenever you think rates have fallen a half-percent or more. If your loan is $150,000-275,000, call when rates seem to be down a percent or so. If your loan is much smaller, you'll need a bigger drop.
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