ReFi-Fo-Fum - Slaying the Mortgage Beast
October 27, 2005 - By Thomas B. Horton

Are you worried interest rates are beginning to rise, and you’ve missed out on the refinancing boom? Assuming you have no prepayment penalty in your loan documents (most do not these days), you may be wondering if you should take any action.

Many of the tried and true rules of thumb still apply: Determining total refinancing fees, calculating the monthly payment savings and breakeven point to recover upfront costs, and knowing how long you plan to stay in the home. However, the refinancing decision now goes well beyond the old “two percentage point interest rate difference” criteria.

Let’s look at some less talked about considerations.

Time Value of Money. Remember that in most refinancings you are paying a lump sum of cash now in order to save a monthly stream of dollars later. Since $1 today is more valuable than $1 next year, this must factor into your breakeven analysis of time to recoup your “investment”.

I know what you are thinking – “I’ll just roll the closing costs into my new mortgage.” In effect, you are financing administrative costs over a 30 year period, which is often even worse than putting them on a credit card! Also, remember that coming up with cash for refinancing often means raiding your savings or cash reserves. Be very careful about this in these economic times, when it really is true that cash is king.

Hybrid Anyone? Many people in this area tend to be susceptible to frequent home moves or transfers, and may be candidates for a hybrid rate mortgage. These loans combine the features of a fixed and adjustable rate loan.

Sometimes referred to as 5/1, or 7/1 rates, these types of loans provide a fixed interest rate for a number of years, and then switch to an adjustable rate every year thereafter. Of course, you could always refinance again before the adjustable portion of the loan takes effect. Since the “fixed” portion of these hybrids tend to be lower rates than a traditional fixed rate loan, these types of loans tend to work well for those who know for sure they will be moving, refinancing, etc. their mortgage within a defined period of time.

Lesser Evil? Many who refinance do so to extract equity from their home for other things such as paying off high interest credit cards. In doing so, you are basically trading one kind of debt for another.

In many cases the interest rate difference is 10% or more, but because you are now financing your old credit card debts through your 15 or 30 year mortgage, total interest costs may not be that much different. You really need to do the math first, and may find that you are better off using the new monthly mortgage savings to pay off existing credit card balances by sending extra money each month instead of paying them off in a lump sum.

Are there situations where you should not refinance? You bet. Those who are well into their current loan period may not benefit from starting over with a new long-term loan. Also, those whose credit ratings have slipped since their last mortgage may find advertised mortgage rates are unattainable by them. Finally, refinancers who tap into their equity, causing their loan to value ration to go above 80% may re-incur Principal Mortgage Insurance costs which will add to their new monthly payment.

The bottom line is, it always pays to check with a financial professional before making any refinancing decisions.

Thomas B. Horton, RFC, is an independent, fee-only financial planner in Shelby Township. He offers objective, no conflict advice on an hourly, as-needed basis. His practice specializes in comprehensive financial planning for individuals and families. Visit his web site at www.HortonFinancialPlanning.com or call (586) 997-3717 to schedule a no obligation appointment.

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