The rush to refinance
The mortgage interest rates have gone down again. Does that mean that refinancing is the best thing you can do?
It’s a dirty little secret that most of the homeowners who are under water got there through refinancing, not by borrowing for their initial purchase. It was tempting to buy new kitchens, cars, vacations, college educations and just junk by using cash-out refinancing products. These products were given out like candy. (Let’s not even bother trashing home equity loans; that’s just too easy.)
While housing prices were going up, the “value” in equity was burning a hole in a lot of people’s pockets. You felt rich. If you paid $250,000 for a house that’s worth $500,000 five years later, you are $250,000 ahead, right? Wrong. It seemed perfectly reasonable to borrow only $50,000 or $100,000 of the profits. Right? Even more wrong.
At a time when real wages were not going up for Americans, borrowing on home equity became the way to feel prosperous. It was just a feeling. You still had to pay it back with your income, which was not going up in relation to inflation.
Then, there are all the additional costs of those cash-back refinancing loans:
Cost of the refinancing service: even if you get a “no points, not closing cost” loan, you are paying for it somehow. Sometimes the rate is higher than a mortgage with more fees. Sometimes the fees are added into your principal.
Time: suppose you refinance into a new loan after three years, you can be hurting yourself by setting the clock back. If you go from a 30-year product to another 30-year product, you are adding years to your payments. Are you really ahead? Most of the time, no. Also, interest is front-loaded, so your lender takes more interest from you in the first years.
Here’s some quick math: (corrected 1/6)
(This is without taking any cash back.)
If you borrowed $325,000 at 6.125 percent, the principal and interest is $1975. Three years later, you reduce your rate to 5.125 percent, and you borrow what is due on your existing loan – about $312,000. The principal and interest is now $1699. Wow, you are saving nearly $275 a month. (That's $99,000 over the life of the loan.)
But, you are paying your loan for an additional three years. Add the 36 more payments of $1699; that’s $61,164. That cuts your savings some, doesn't it?
When borrowers refinanced with cash back, they frequently were not ahead if they looked at the added payments. Also, most refinances do not drop a full percentage point. Do the math for yourself.
Real estate advice in the current refinance boom: If you can afford to shorten the term of your loan, you will be in much better shape. Otherwise, don’t rush into a low rate without looking at the whole picture.
Note added 1/6/09 -- both spelling an math errors are corrected. I appreciate all constructive criticism. Thank you. RF
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A good friend of mine who is a mortage originator tells me half the deals he brings in, die because of low ficos, low appraisals, tighter underwting criteria, etc.
These are all loans he claims were a pice of cake to close 3 years ago. This will
not end well.
Shortening the term of the loan is the key. Even if you can't get into a 15 year loan, and take another 30 year, if you keep paying that extra $200 a month, you will pay off the 30 year mortgage in approximately 23 years. This is 4 years sooner than you would pay it off if you had not refinanced, saving you approximately $76,000. That's no small potatoes.
Unfortunately, very few people think like that. They think it's better to have lower payments and pay them for infinity. Maybe we need some sort of public service campaign to get people thinking about how amazing it is to pay off their mortgage.
People really don't take the clock reset properly into account. I don't think that can be emphasized enough - most people are totally uneducated about that.
And cash-out refi's are just horrible for the average person. Slow financial suicide.
We really need more financial education in this country (granted this post helps)
those extra 36 months of payment only really matter if you stay in the house for a long time. if you're planning on moving in 5 to 10 years, it's not going to matter as much.
also, can you really pay down $35K in 3 years? that seems a little high.
Terrific post!
My wife and I are refinancing right now. We took the original loan early last year. 30 yr. fixed at 6.375%. We are refinancing into a 30 yr. fixed at 5.375%, no points, no closing. I don't worry about going back to the beginning of a 30 yr. fixed because we haven't even been in the current loan for a year, and there is an almost zero percent chance we will ever stay at this house anywhere near 30 years. The only thing we have run into is a lower appraisal, (surprise, surprise!) so we will actually have to pay a small amount of PMI every month for a while. We will still save a moderate amount each month and we will get the 5.375% rate even when the PMI disappears.
Good post, except the financial term is "principal", not "principle" (which is something else). Education should be better not just in mathematics but in language as well.
"Even if you can't get into a 15 year loan, and take another 30 year, if you keep paying that extra $200 a month, you will pay off the 30 year mortgage in approximately 23 years. This is 4 years sooner than you would pay it off if you had not refinanced, saving you approximately $76,000. "
The extra 200 dollars has an opportunity cost. If all depends upon the mortgage interest rate. Other investment options may utimately provide a better rate of return than the mortgage interest rate, and over the long term, this is a distinct possibility.
" suppose you refinance into a new loan after three years, you can be hurting yourself by setting the clock back. If you go from a 30-year product to another 30-year product, you are adding years to your payments."
However, most people do not stay in one place long enough to pay off their mortgage. Also, the mortgage deduction needs to be factored into the equation. And, in an inflationary environment, if you happen to keep your home for 30 years without moving, those dollars 30 years into the future are worth alot less. Inflation could happen moving forward, if our govt overshoots during the recovery and prints too much money and if the price of oil skyrockets again when demand returns.
As a Certified Residential Real Estate Professional with years of experience, my suggestion is simple..............
"Know what you are doing and completely understand what you are getting into".....A little bit of knowledge is dangerous.............
I have seen it all , twice !!!!!
Personally I think you should plan, if at all possible, to buy for the long term. Most people forget to factor in the cost of setting the clock back, because they are focused on buying the bigger better house that they may never really own. If you keep setting the clock back, the only "equity" you have is market driven. The earlier years of your mortgage is all interest. Also, since the interst you pay is also a tax saving, lower rates aren't as great as they sound if you realize. Lower rates = less tax savings. Best bet is keep the amount you borrow as small as possible instead of as much as you can get which has been the norm
I like it. Pay more interest. That is a good move ; )...seriously, got to be kdding me...Bostonrunner is spot on...
Yes, but you forgot to mention that with people being in dire straits, losing their jobs, $, stock market, 40lk's? that what a "refinance" does, is buy you time so you can KEEP your house. I went from a 15 year to a lenghthen 20 year - SAME rate - but I save $800 a month (on $510k)
So, sometimes it IS worth it.
Real life example:
$417K Loan originated March 08 @ 6.25% = 2,568/mo
$413K Loan refinanced Jan 09 @5.5%= 2,345/mo
No points/no closing costs
If I choose to keep paying the $2,568/mo I will save $147K and pay off loan in 25.25 years from the original date of 3/8/08. This saving would be offset by the tax savings, so about a $100K after tax savings. and that is only .75% lower refinance.
Should I do it?
Shop well. Rates* can adjust hourly. ITS THE FEES & POINTS THAT CAN ADD MORE TO A LOW RATE. To do best, position yourself to strike. Have several brokers working for you..... to look for the dip that will be your trigger. Don't over commit to one. A full point.............6.3 to 5.3 is good. It is all Relative. The greater the spread, the more is in their pocket vs. your savings. Same day it may hit 4.9% Be patient. Not all is bad out there! Good opportunity.
A couple (unrelated) points:
- The tax savings are overrated. Don't forget about the standard deduction and don't forget that these deductions phase out at certain income levels
- I just refinanced. The new home appraisal came in ~10% higher than the purchase price in 2007 and I never had to verify income. This to me means that this industry is not done shaking off its recent excesses...
Before refinancing always determine what your total cost of interest will be for the new loan add it to the total interest you have already paid and compare it to the total interest you would have paid for the old loan. If the latter is less than the former you are a winner. In addition it takes pressure off of your monthly outlays or allows you to pay down the loan faster.
Rona-Please check your math again. 325K loan at 6.125% is $1975/mo P&I. After 3 years you would owe $312K. 312K @ 5.125% is $1,699/mo P&I. That is $276/mo difference. You will save close to $100K if you refinance and pay the same amount....or because very few people stay in there home for ever, you can just increase your new payment by $20 and be paying down the same principal each month as you were with the original loan, but for $255 less a month!!
2 years from now, you will owe the same principal, and have $6500 in bank if investing the $255/mo. You should refinance!! Thanks, Bill
to the folks claiming they are getting 5.5% or 5.375% no closing costs....read the fine print. the market is nowhere near that as a price. 5.5 or 5.375 is with closing costs, no points..but with costs. Lenders have very little appetite to offer no closing cost pricing in this market, as there is significant loss risk if rates drop again within 6 months of your close date...the bank never makes their money back. Lots of slick operators are still playing the game, and trying to up your loan amount...claiming no cost, since you have nothing "out of pocket"
if you dont have it in writing...it's worth the paper it is printed on.
Life in this modern world is very hard for stupid people who can't do math because the lenders can do math and they're very good at it. They're not very good at underwriting, but they're very clever at math. Back in high school when you dodged the hard courses because "I'm never going to use this", well, guess what? You are. Should've studied harder
BTW, as already mentioned, the balance that you owe on a loan is the "principal", not the "principle". Spellcheck is a wonderful thing but can't help you with homonyms. Did all the copy editors get laid off?
rona, bill's right. it's a thought provoking post but your figures are way off by my calculations. the difference between $325k @ 6.125 and $312k @ 5.125 would be $275/mo. assuming no pre-payment penalties, you could take the $275/mo put it right back into the mortgage, wrap it up in 21 years or 5 years quicker than the original obligation and save yourself $115k in interest. don't spike the payments and you still save yourself $25k in interest over the life of the loan ($385k v. $360k). the other side is even if you could theoretically find a sweet spot where the reset would not outweigh the benefits of the immediate savings you're still comparing 2009 dollars to 2034, 2035 & 2036 dollars. quick example, in 1980 ma median home price was $48,400 unadjusted. Assume 20% down and $38,720 financed @ 5.125% you're looking at a $210/mo payment for the rest of this year and next on a 30 year fixed. that additional 3 years of $1700/mo projects to the equivalent of a commuter rail pass.
JoeBagofDonoughts-I am refinancing with no cost to me....the same amount I owe now...no lawyer fees, processing fees, closing costs, or points etc...the loan amount I am financing is the payoff figure...If I wanted to pay points, I can get down to 5%, but I don't want to pay points incase I am short-term and rates go down another 1/2 point, then I wll do the same thing again in 4 months...no cost to me...the slick operator happens to be my brother, which means I am getting the family discount!! Yup, I am paying more then if I used competitve brokers...but I have to feed my brothers family ; ).
Cash flow has value. Life can be a lot easier if you can reduce that overhead by $200 per month.
I am glad that you are getting my point. Today, I failed both math and English. The math mistake happened because I started with principal and interest cost of a $300,000 loan, not a $325,000. From there, the error keeps rolling…
As for the copy editors. My regular readers already know that Scott and I fly without copy editing. So, any mistake is ours and everything that is right is ours, too.
Hi Bill, here's my answer to your real life example:
Real life example:
$417K Loan originated March 08 @ 6.25% = 2,568/mo
$413K Loan refinanced Jan 09 @5.5%= 2,345/mo
No points/no closing costs
If I choose to keep paying the $2,568/mo I will save $147K and pay off loan in 25.25 years from the original date of 3/8/08. This saving would be offset by the tax savings, so about a $100K after tax savings. and that is only .75% lower refinance.
Should I do it?
Go for it!
Your figures are for a 30-year loan product refinancing into a new 30-year loan product.
You will owe $412,949.31 at the tenth month or $412,532 at the eleventh month, depending on when you close. You are borrowing a little more, just to round up.
The difference is $2568-$2345 = $223 a month for 360 months. Savings: $80,280.
You will pay another ten or eleven months at the end; let’s say ten. Losses: $25,680.
You are ahead on this, if there aren’t any fees hiding in your loan.
The tax savings help shelter income, but I do not advise people to count it as saved money.
Rona, excellent post!
The important part is, you got the PRINCIPLE spot on - people need to put appropriate thought into deciding to refinance or not, and why.
the point is not you have egg on your face b/c you did some math wrong. everybody makes mistakes. the rub is that bad advice is infinitely worse than no advice at all. this is actually a pet peeve i have w/ agents and brokers. they advise on topics that they are not experts and often have done little to nothing to educate themselves about. should people scrutinize the advice? obviously. do many blindly trust real estate and mortgage professionals to their detriment? absolutely. rona you have real experience and bring real value to the table. my advice to you would be to focus on what you do well.
ps the people that are worried about "ple" v. "pal" need a hug.
Still waiting,
I take all constructive criticism seriously. In this case, I disagree that the advice was bad. I think the example was the problem.
My example had a relatively short period between the initial loan and the refinance, it had no additional principal added, and it had a huge rate decline. I chose those numbers because I didn’t want to overstate the case. Because of my math error, I understated the case.
My advice stands. Around the third or fourth year of most loans, the total cost of the loan generally increases due to payments you are tacking onto the end. It varies based on the rate change and the principal.
Everyone should do the math. At least twice.
PS, I will be posting on some of the very good reasons readers have mentioned for refinancing even if the overall cost is higher.
Frankly, I think Rona's advice was very good.
Refis get a lot more people into trouble than they help. Not to say they don't have a use for some, but the track record of what actually happens, not what theoretically happens, is grim.
i'm not even sure how to respond to that. your advice was blatantly wrong. i'm not exactly sure why you would want it to stand but c'est la vie. a 1% reduction in the conforming mortgage interest rate in today's volatile world is far from huge. it's actually rather pedestrian. happens over the course of a couple of weeks. tackling cash outs is a whole nother topic and largely irrelevant to whether a responsible borrower should refi. your points regarding the front loaded nature of interest repayments and timing do have some merit, however there's really no need to complicate this. the cost of the loan is called interest. if your amortization chart says that the amount of interest paid to date plus the amount of interest anticipated over the course of the new term is smaller than the amount of interest you would pay if you did not refi then you do it. especially seeing as you can take the difference in payments and put it into the stock market where 10% returns are guaranteed.
Can anyone tell me what basic value in a commercial property appraisal means?
Can anyone tell me what term "basic value" ,which is used to describe the value amount for property , in a commercial real estate appraisal, means? Is this the same as a "fair market value" appraisal for this property"?
This appraisal report does not state the reason for the appraisal.
The property was to be appraised at "fair market value" for a trust and divided between 3 beneficaries. The trustee/beneficary has the option to purchase the property. thank you
Thank
i
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