Refinancing? Here's How To Figure The Angles

When interest rates drop, homeowners' thoughts naturally turn to mortgage refinancing. Fixed rates on 30-year conventional mortgages are now averaging 9.5%, their lowest level in four years, and they could dip a little lower still. Traditional financial wisdom says that anybody who is paying two percentage points above prevailing rates and planning to stay in the same house for several years should start shopping for a new loan.

But don't let tradition hold you back if you're paying 10.5%. Even those who are comfortable with their present mortgage payments should remember that just one percentage point makes a big difference in the long run. If you took out a $150,000 mortgage last year at 10.5%, paying it off at 9.5% would save $25,700 in interest over the life of the loan. And for people even slightly insecure about their jobs, lopping $200 or so a month from fixed expenses can be quite a stress-reliever.

Still, the biggest factor in refinancing should be how long you intend to stay in your house, because closing costs are so high. Most people who refinance choose a fixed-rate mortgage. If you don't sell for five years, you'll come out ahead by dropping down just one point. And if your rate comes down by two points, you'll recoup costs in about 2 1/2 years (table).

TEASERS. On the other hand, if your house has just gone on the market, or if you think you may move out within a couple of years, a one-year adjustable-rate mortgage (ARM) may make more sense. Many lenders now offer one-year ARMs with initial teaser rates as low as 6.5%. Switch into one of those from a 30-year, fixed-rate loan at 10.5% or more, and you'll recoup your closing costs in less than a year.

Of course, going from fixed to adjustable rates sounds risky--because most of us are dogged by the high-inflation mentality of the late `70s. But it's no longer a given that ARM rates will keep spiraling to their maximum.

In a worst-case scenario, a one-year, 6.5% ARM with a 2-point annual cap and a 6% lifetime cap will go up to 12.5% in four years. Even so, payments over those four years would be slightly less than with a 30-year, 9.5% fixed mortgage. Before you assume that an ARM will be expensive, figure precisely what you'll save in interest over what period of time.

There are plenty of books and software programs that help tabulate savings. One painless way is offered by The Banker's Secret software ($42.95, phone 800 255-0899). Author Marc Eisenson's emphasis is on the thriftiest approach: refinancing and using the resultant monthly savings to prepay your principal. Sending the lender an extra $100 a month on a 10.5%, 30-year loan of $150,000 will save you more than $118,000 in interest and shorten the loan term by 8 1/2 years.

BAD DREAM. Another option is converting your 30-year fixed mortgage into a 15-year one, where the prevailing rate is around 9%. Because you will be paying back the principal faster with a shorter-term loan, your monthly payments remain the same. But you save a bundle on interest, and you own your house outright twice as soon.

Unfortunately, refinancing is like a recurrent nightmare: It involves the same lengthy process and the same fees as getting your first mortgage, because you're essentially paying off the first loan and taking out a new one. Once again, the lender will hit you with "points," each equal to 1% of the loan amount. Usually, the more points you pay, the lower the interest rate you can get. (Bear in mind that interest on a jumbo loan--over $191,000--runs a half-point higher. Also, unlike a home purchase, a refinancing's points are not tax-deductible.) Next come fees for the application, a new appraisal, a title search, and the legal work.

Total refinancing costs run 3% to 5% of the loan amount. Prepayment penalties are no longer common, but even so, check your original loan agreement to make sure none are mentioned.

TRACK RECORD. There's some leeway here. Sticking with your current lender can cut closing costs on a refinancing by about 25%. The institution may waive appraisal, title-search, and possibly credit-check fees, especially if your payment record is good.

Even new lenders will take into consideration what's known as your "willingness to pay," or your track record in sending in prompt mortgage checks, as seriously as they will your ability to pay, says Paul Havemann, vice-president of mortgage-lender survey firm HSH Associates, and possibly give you a break on certain fees. "Everything's negotiable," says Havemann. "Some borrowers will get lucky and pay a grand in closing costs, others as much as five grand."

Since the banks are competing more fiercely than ever and since the real estate market is slow, a smart shopper should be able to find an attractive deal. Warren Lasko, executive vice-president of the Mortgage Bankers Association of America, says inquiries about refinancing have been pouring in. Economists and the Federal Reserve Board are already promising an economic turnaround by 1992--so it may be years before mortgages look this good again.

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