TO REFINANCE OR NOT TO REFINANCE?
That is the question, but how to find the right answer? First things first – have your goals together. Mortgage Lenders are great at putting together loan options, but they are often times basing those options on what you tell them. If you are asking for the lowest rate, they will put those options in front of you, but surprisingly they may not always be the best options. Wait!? What, the lowest rate isn’t always the best option? Of course not – considering that the lowest rates are adjustable, or shorter loan terms with payments that may be out of reach for you. So, let’s look at your goals for the refinance:
Number 1: I WANT TO SAVE MONEY!
Everyone likes to save money – we like to save money! That’s why we’re writing this blog instead of mailing you a letter. Letters cost stamps! Let’s be more specific: do you want to save money now, as in lowering your monthly debt payments, or do you want to save the most over the term of the loan? Are you struggling to make the payments you currently have, or does your end of month surplus cash look like the US Treasury’s?
The best place to start is by looking at your budget. How much are you spending on all of your debt each month? Is that a high or low percentage of your monthly income? Do you have discretionary funds? Do you have a large amount of unsecured debt? How did you get to where you are and what changes need to be made to not get there again (if it’s not where you want to be)? Is your retirement savings on track? Having the answers to these questions before approaching a refinance is a great idea. Even better – meet with your financial planner before talking to your lender to help put these answers, and goals, together. Define what “saving money” looks like for you first.
Number 2: I WANT TO LOWER MY PAYMENTS
Debt isn’t much fun (well, it is for us, but for different reasons than you would think), but what it offers can be great. Mortgage loans are necessary for most people to own a home. We think owning a home is great! Auto loans are generally necessary to finance your transportation. Student loans – education. Credit cards? We’re not much of a fan of these. Using a credit card for convenience and paying off the balance each month? That’s generally a good thing. Credit cards are bridge financing if you carry a balance – the interest is costly and paying the minimum will take forever to pay off the balance. The point is: carrying the right kind of debt is ok, but eliminating the wrong debt is essential to your financial health. Sounds like we are talking about cholesterol here and the analogy works: having a mortgage loan is like HDL- your financial health is better with this kind of debt, but high a high credit card balance is like high LDL and puts your finances on the path of systemic failure. Refinancing offers an opportunity to right the ship, a “statin” for your system. By eliminating the bad debt and restructuring/lowering your monthly debt payments you can bring your finances to a better place. But beware – the last thing you want to happen is to combine all of your debt, lower your payments and then go on a spending spree. It’s important to take full advantage of the opportunity and create a sound financial plan to avoid adding the “LDL” debt again in the future. If your payments are reduced, plan to put some emergency money away and make sure you can pay off that credit card each and every month for good.
Number 3: I NEED TO FIX OR IMPROVE MY HOUSE
Construction loans, credit lines, fix up funds and often times local money is available in addition to your existing mortgage loan. Sometimes it doesn’t make sense to refinance your current mortgage just to get some money to put a new roof on the house. Look at the terms of your current mortgage and what is available from your lender. If the interest is going up on your current loan by more than what you would save on the construction financing portion, then just add the construction loan instead. Generally construction financing rates are higher than first mortgage rates, but if you are borrowing a small amount or your current mortgage has a much lower rate, then adding the secondary financing is a better option. If the construction project is larger, then it might make sense to refinance to a construction loan program like FHA 203k or Homestyle so that you can make the improvements and get a low, fixed rate loan for the project and your current mortgage balance all in one.
Number 4: I WANT TO LOWER MY TOTAL COST
Long term planners – this paragraph is for you. How much does the rate need to decrease for a refinance to make sense? If your other debt is in order, and your home is perfect as-is, then let’s look at break even points and a cost-benefit analysis. The absolute way to compare your current loan to a new loan is how much and how long. Take your current payment times the remaining term to calculate a total cost on your current loan. If the refinance option reduces that total number by an acceptable amount, by the same math (how much times how long), and the payment works, then it generally makes sense to do. Let’s look at an example:
Current principal and interest payment (exclude taxes and home insurance): $1200
Remaining number of payments on your loan: 280
Total cost: $336,000
New 15 year loan principal and interest payment: $1516
New total cost: $272,880
If the higher payment fits into your budget, this certainly makes sense to do if you are looking for long term savings. Even if the refinance costs $3,000, the savings is about $60,000 over the term. This is a common scenario right now for many 30 year loans with rates in the mid-4% range to refinance down to a 15 year term. You should also compare the total cost on your current loan if you simply increased the payment, but generally the refinance will add up to more savings.
The other calculation you need is the break even point. At what point in the future will I recoup all of the costs of doing the refinance? Two ways to calculate the break even offer manipulation of this time frame. One way to calculate break even is on the interest savings. If you save .625% in interest on the loan (reducing the rate by this much) and the refinance costs 2.375% of the loan amount, then it will take 3.8 years to recoup (ignoring time value of money and the decreasing benefit of interest savings over time). If you are a spreadsheet guru you could put this into an amortization table and calculate the exact break even by interest savings, but hey, life isn’t exact anyway. The other way to calculate break even is on a cash flow basis, but this isn’t as effective a calculation. If the monthly payment savings is $300 and the loan costs $6,000, then it will take 20 months to break even. The reason this approach is flawed is that you might be extending the term on your loan for this payment savings, which would potentially cost more in the long run. The simple formula here is: cost divided by benefit. That will yield the break even point. Have your lender help, and if they don’t know how to calculate this for you, then find a different lender!
Number 4: I WANT TO REDUCE MY TAX BILL
Mortgage interest is tax deductible. If you consolidate other debt that doesn’t have tax deductible interest, you could reduce your overall tax liability. Bring in your CPA and let’s have coffee with calculators. It’s great fun, and so is saving money! We think the government has enough to work with anyway, so why give Uncle Sam more than he has contracted for?
Number 5: I STILL DON’T KNOW WHAT TO DO
This likely has been more fun for us to write than for you to read about it. We are only going to complete a refinance for you if it makes financial sense to do so. Sure, completing loans is fun, but we need to make sure it is to your benefit. MN State law requires that the loan have benefit for you, and we’re you’re fiduciary, which means we need to look out for your best interests (no pun intended!). Bring your questions and scenarios to us and we’ll crunch numbers, calculate the savings, project long term costs, ask CPAs for tax analysis, talk with financial planners about retirement and other savings goals, and have you leaving our office more confident in your financial future. Maybe then you can spend more time working on getting that LDL lower instead of worrying about making extra payments on that credit card that seems to be stretching out to infinity.
This message was released by the U.S. Department of Housing and Urban Development covering the newest update to FHA loans.
Mortgagee Letter 2013-26
Date: August 15, 2013
To: All FHA-Approved Mortgagees
Subject: Back to Work – Extenuating Circumstances
Purpose: The purpose of this Mortgagee Letter (ML) is to:
- Provide minimum underwriting standards and criteria for evaluating
borrowers who have experienced an Economic Event, as defined in
this ML, that resulted in a severe reduction in income due to a job loss
or other circumstances resulting in reduced Household Income;
- Describe the use of housing counseling to qualify under the provisions
of this ML
- Amend HUD Handbook 4155.1, Chapter 4, Section C to add an
Economic Event to the list of examples of extenuating circumstances
and instruct lenders to use the guidance for Back to Work –
Extenuating Circumstances established in this ML as Chapter 6
Section G, to underwrite an applicant with an Economic Event; and,
- Revise HUD Handbook 4155.1, 4.A.7.e, to clarify the process for
requesting a review of information contained in CAIVRS for
borrowers seeking an FHA-insured mortgage in accordance with the
provisions of this ML.
FHA is continuing its commitment to fully evaluate borrowers who have experienced periods of financial difficulty due to extenuating circumstances.
As a result of the recent recession many borrowers who experienced unemployment or other severe reductions in income, were unable to make their monthly mortgage payments, and ultimately lost their homes to a pre-foreclosure sale, deed-in-lieu, or foreclosure. Some borrowers were forced to file for bankruptcy to discharge or restructure their debts. Because of these recent recession-related periods of financial difficulty, borrowers’ credit has been negatively affected. FHA recognizes the hardships faced by these borrowers, and realizes that their credit histories may not fully reflect their true ability or propensity to repay a mortgage.
To that end, FHA is allowing for the consideration of borrowers who have experienced an Economic Event and can document that:
- Certain credit impairments were the result of a Loss of Employment or a significant loss of Household Income beyond the borrower’s control;
- The borrower has demonstrated full recovery from the event; and,
- The borrower has completed housing counseling.
Housing counseling is an important resource for both first-time home buyers and repeat home owners. Housing counseling enables borrowers to better understand their loan options and obligations, and assists borrowers in the creation and assessment of their household budget, accessing reliable information and resources, avoiding scams, and being better prepared for future financial shocks, among other benefits to the borrower.
The guidance in this ML is effective for case numbers assigned on or after August 15, 2013 through September 30, 2016.
Welcome to our Real Estate Glossary. We hope that these definitions will help you to better understand the home buying and selling process.
Adjustable-rate mortgage (ARM): a mortgage in which the interest rate is adjusted periodically based on a pre-selected index. Also sometimes known as a variable-rate mortgage.
Amortization: loan payment by equal installments of principal and interest, calculated to pay off the debt at the end of a fixed period.
Annual percentage rate (APR): the interest rate reflecting the cost of a mortgage as a yearly rate. It allows homebuyers to compare different types of mortgages based on the annual cost for each loan.
Appraisal: a document giving an estimate of a property’s fair market value; generally required by a lender before loan approval.
Assessment: a local tax levied against a property for a specific purpose, such as a sewer or street lights.
Balloon (payment) mortgage: usually a short-term fixed-rate loan which involves small payments for a certain period of time; after that time period elapses, the balance is due or is refinanced by the borrower.
Cap: a consumer safeguard on an adjustable-rate mortgage that limits how much a monthly payment or interest rate can increase or decrease.
Certificate of eligibility: document given to qualified veterans entitling them to Veteran’s Administration guaranteed loans. Obtained by sending DD-214 (Separation Paper) to the local VA office with VA form 1880 (request for Certificate of Eligibility).
Certificate of reasonable value (CRV): appraisal issued by the Veteran Administration showing a property’s current market value.
Closing: the meeting between the buyer, seller, and lender or their agents where the property and funds legally change hands.
Commitment: agreement, often in writing, between a lender and a borrower to loan money at a future date subject to the completion of paper work or compliance with stated conditions.
Construction loan: short term interim loan to pay for the construction of buildings or homes. Usually written to provide periodic disbursements to the builder as progress is made.
Contract sale or deed: contract between buyer and seller of real estate to convey title after certain conditions have been met.
Conventional loan: a private sector loan, one that is not guaranteed or insured by the U.S. government.
Credit report: documents an individual’s credit history, listing all past and present debts and the timeliness of their repayment.
Debt-to-income ratio: the ratio, expressed as a percentage, which results when a borrower’s monthly payment obligation on long-term debt is divided by their gross monthly income.
Deed of trust: in many states, a document used instead of a mortgage to secure the payment of a note.
Default: failure to make the monthly payments on a mortgage.
Delinquency: failure to make payments on time. This can lead to foreclosure.
Down payment: the portion of a home’s purchase price paid in cash and not part of the mortgage loan.
Earnest money: money given by a buyer to a seller as part of the purchase price to bind a transaction or assure payment.
Equal Credit Opportunity Act (ECOA): a federal law requiring lenders to make credit equally available without discrimination by race, color, religion, national origin, age, sex, marital status, or income from public assistance programs.
Equity: an owner’s financial interest in a property; calculated by subtracting the amount still owed on the mortgage from the fair market value of the property.
Escrow: an account held by the lender into which the homebuyer pays money for tax or insurance payments.
FHA: the Federal Housing Administration provides mortgage insurance to lenders to cover most losses when a borrower defaults; this encourages lenders to make loans to borrowers who might not qualify for conventional mortgages.
FHA loan: loan insured by the FHA open to all qualified home purchasers. While there are limits, they are generous enough to handle moderately priced homes almost anywhere in the country.
FHA mortgage insurance: a policy paid at closing to insure the loan with FHA.
Fixed-rate mortgage: mortgage with payments that remain the same throughout the life of the loan because the interest rate and other terms are fixed.
Foreclosure: a legal process in which mortgaged property is sold to pay the loan of the defaulting borrower.
Hazard insurance: form of insurance in which the insurance company protects the insured from specified losses, such as fire or windstorm.
Lien: a legal claim against property that must be resolved before the property is sold.
Loan-to-value (LTV) ratio: a percentage calculated by dividing the amount borrowed by the sales price or appraised value of the home to be purchased.
Lock-in: guarantees a specific interest rate if the loan is closed within a specific time.
Market value: the highest price that a buyer would pay and the lowest price a seller would accept on a property.
Mortgage insurance: a policy that protects lenders against some or most of the losses that can occur when a borrower defaults on a mortgage loan; usually required with a down payment of less than 20%.
Mortgage modification: an option that allows a borrower to refinance and/or extend the term of the mortgage loan thus reduce the monthly payments.
Origination fee: fee charged by a lender to prepare loan documents, make credit checks, inspect and sometimes appraise a property; usually a percentage of the loan’s amount.
Points: prepaid interest charged at closing by the lender. Each point equals 1 percent of the loan (e.g., 2 points on a $100,000 mortgage would be $2,000).
Prepayment: permits the borrower to make payments in advance of their due date, thus saving money on interest.
Prepayment penalty: charges for the early repayment of debt.
Principal: the borrowed amount, less interest or additional fees.
Private mortgage insurance (PMI): insurance paid by the borrower. This may be required by the lender when the down payment is less than 20%.
Realtor: a real estate agent or broker affiliated with the National Association of Realtors and its local and state associations.
Recording fees: money paid to the lender for recording a home sale with the local authorities, thereby making it part of public records.
Refinancing: paying off one loan by obtaining another; refinancing is generally done to secure better loan terms (like a lower interest rate).
RESPA: Real Estate Settlement Procedures Act allows consumers to review information on known or estimated settlement cost once after application and once prior to or at a closing. The law requires lenders to furnish the information after application only.
Second mortgage: a mortgage made subsequent to another mortgage and subordinate to the first mortgage.
Survey: a measurement of land, prepared by a registered land surveyor, showing the location of the land with reference to known points, its dimensions, and the location and dimensions of any buildings.
Title: a document that gives evidence of an individual’s ownership of land.
Title insurance: a policy, usually issued by a title insurance company, which insures a home buyer against errors in the title search. The cost of the policy is usually a function of the value of the property, and is often bome by the purchaser and/or seller.
Title search: a check of public records to be sure that the seller is the recognized owner of the real estate and that there are no unsettled liens or other claims against the property.
Truth-in-lending: a federal law requiring disclosure of the annual percentage rate charged to home buyers shortly after they apply for the loan.
VA loan: a long-term, low- or no-down payment loan to veterans guaranteed by the Department of Veterans Affairs.
Verification of employment (VOE): a document signed by the borrower’s employer verifying his/her position and salary.
- Identify what the negative items are that reporting in your credit file. You can review all of your credit information here:www.annualcreditreport.com. AnnualCreditReport.com is the official site to help consumers to obtain their free credit report. It is a free service as long as you do not request your credit score. The individual credit scores usually cost around $7 each. The catch ‚ only one review per year is free. Once you know what the negative items are, you can begin correcting them. Review everything in detail, and if something is reporting inaccurately, request a dispute right on this web page. If you have outstanding collections/judgments/past due accounts, be sure to get them paid as soon as possible.
- Create some positive trade lines on your credit. A trade line is an account that reports to the credit bureaus. Typically, a utility bill or cell phone account is not considered a trade line, but an auto loan, student loan and credit cards are considered trade lines. Make sure that you have some positive trade lines of varying types reporting on your credit. If not, open one or two. A great way to get a loan or credit card when your credit is lacking or in rough shape is via a secured loan or secured credit card. US Bank has a great program for this, go and see my banker Emily Ervin in the Bloomington branch.
- Save documentation! If you pay something in full, get a paid in full letter from the creditor. Start a file on all the receipts you receive, as well as payments that you make.
- Follow up. If you review all three credit bureaus at one time, you cannot review them again for 12 months. Instead, review one report of the three, one at a time. I will review my report every 4 months by only reviewing Transunion, Experian and Equifax one at a time.
- Check with a professional. Credit experts and mortgage lenders can help you review your official report. If you can correct some things on your own, do that first before contacting a lender or credit expert. A great credit repair resource here locally is Warren Bauerfeld, 612-889-1117. Please mention us when you call him.
Lenders usually take a positive view of individuals with a range of credit accounts – car loan, credit cards, mortgage, etc. – that have a record of timely payments. However, a high debt to credit ratio on certain types of revolving (credit card) accounts and installment loans will typically have a negative impact.