Some Considerations When Refinancing

When making a decision to refinance your mortgage, there are several factors to keep in mind.There are often many reasons to refinance your mortgage. Often it is to get at lower rate. Other times, it is to consolidate other debts such as expensive credit cards. For others, it is to get access to the equity in your home for home improvements, investments, college tuition or for other reasons. If you have a lot of credit card debt, a new mortgage rate is about the same as your current rate will still save your a lot of money each month. In this article, I want to go over some of the topics you need to consider before refinancing your mortgage.

Finance Your Closing Costs
When you refinance your mortgage, you will have several closing costs that can add up to 2% to 3% of the amount financed. Typically, these fees such as an application, an appraisal, title insurance, recording fees, certification fees, underwriting fees and other fees, are added to the new loan balance. However, it is possible that, these fees can be paid by the mortgage company in exchange for an interest rate, that may be a percent or more higher than what it would have been, if you included these fees in the new loan balance.

Paying Points
If you are planning to stay in your home for at least three to five years, it may make sense to pay “points” (a point equals 1% of the loan amount) and closing costs to get a lower interest rate. On a $100,000 mortgage, 1 point is equal to $1,000.

I can show you what your break-even time would be. This is the number of months it takes where the extra fees you are paying become less than the amount you are saving with the lower interest rate.

When you refinance, you can avoid having to lay out the cash by adding the points and closing costs to your new mortgage. Does that mean shouldering a lot of extra debt? Not necessarily. If you’ve had your current mortgage for at least three years, you’ve probably reduced your balance by several thousand dollars. So, you may be able to tack your closing costs onto your new loan and still end up with a mortgage that’s smaller than your original one — plus, of course, a lower rate and lower monthly payment.

Credit Card Debt
If you carry a lot of credit card debt, you face the possibility of not paying off the debt for up to 24 years, if you only make the minimum monthly payments on the debt. At 18% interest, a $20,000 credit card balance will cost you up to $64,000 to pay off, if you only make the minimum payments. Plus, this debt is not tax deductible.

Cut Your Credit Card Debt Payments by up to 75%
On $20,000 in credit card debt, your minimum monthly payments run about $400. If you refinanced that debt into a new first mortgage at 6% interest, your payments on that $20,000 would go down to about $120 per month. When you factor in your first-year mortgage interest costs of about $1200 and a 25% tax bracket, your after-tax cost on the $20,000 debt drops to about $95. This is a monthly savings of over $300 per month, or a reduction of 75%!

Take a One Month Payment Holiday
When you refinance your mortgage, you get to skip your first month’s payment. For example, if you close in April, your first payment is not due until June 1. Now, if you add up all your credit card bills plus your mortgage payment, you can effectively not make that total payment for a month. That can add up to real savings.

Fixed vs. Adjustable Rates
If you are planning on staying in your home for 5 years or less, an adjustable rate mortgage may be to your advantage. Adjustable rate mortgages carry a lower rate for the first 2 or three years. If you believe that rates will fall, then, when your interest rate resets, it will be lower in the later years. If you are not a risk taker, then you would be better off with a fixed rate mortgage.

Pay Off Your Debts Faster
If you have a lot of debt, it makes sense to refinance it all into a new first mortgage, then, take the difference between what you were paying and your new payment to either make extra principal payments, or, to use that cash to create an investment fund.

Gain Tax Advantages
Generally speaking, the interest on a refinanced mortgage is tax deductible. Exceptions arise for homeowners who refinance to cash out equity, and then, use the equity-related funds for something other than improving their home. In this situation, only the interest on a maximum of $100,000 of the equity debt is tax-deductible.

Here’s an example:
You refinance your original $125,000 mortgage for $300,000. The extra $175,000 goes towards vacations, new cars, and other discretionary spending. You can deduct the interest related to the $125,000 refinanced from the first mortgage, and $100,000 of the new equity debt. The interest on the remaining $75,000 would not be tax deductible.

If you are in a high tax bracket, this deduction can greatly reduce the effective interest rate of your mortgage. For example, if you get a mortgage at a rate of 6%, and are in a 28% marginal tax bracket, your effective interest rate is only 4.32%.

Watch Out for One Potential Problem
Often, I see clients who are looking to purchase a new car with either a second mortgage or with a refinanced new first mortgage. The problem with this is you are taking an asset that you may keep for only 4 to 7 years, and finance it with 15, 20 or 30 year money. This means that long after you get rid of the car, you are still paying for it! The same is true for financing vacations with a new first mortgage. You can end up paying for your vacation for up to 30 years if you don’t add extra principal to your loan payments.

Call for a No-Obligation Consultation
If you are looking to consolidate debt, I can provide you a no-obligation debt consultation. Once I look at your credit report, I can show you exactly how much money you can save each month. The last person I talked to I saved him $654 per month and put an extra $18,450 in his pocket. Based on his income, I gave him a 16% raise for the year. It is very possible that I can also give you a raise!

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