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Are the Good Times Over?

Financial Planning

August 2003

Are the Good Times Over?

If you haven’t received at least one offer for a 3.79% mortgage in the last month, chances are you haven’t opened your e-mail lately. Even if you do have a really great spam killer, I honestly don’t see how you could avoid getting at least one offer for a low rate loan. It seems to me that everyone, including George Washington and Abe Lincoln, has been offering to refinance my mortgage lately.

So, what’s the deal with all these low rate mortgages and should you get in on them? The short answer to the question is the Federal Reserve Open Market Committee (the “Fed”) has put money on sale and yes, if you haven’t already, you should at least consider getting in on these low rate loans.

There are several reasons you should jump on the refinancing bandwagon and a few that should keep you where you are, but first, let’s see if the “good” times really are over. After all, mortgage rates seem to be jumping up over the last few months. According to Freddie Mac, one of the key players in home mortgages, the average rate for 30-year fixed rate mortgages, 15-year fixed rate mortgages and 1-year adjustable rate mortgages was 5.94%, 5.27% and 3.67% respectively for the week ended July 24, 2003. The rates for the same period in 2002 were 6.34%, 5.76% and 4.31%. The change is even more dramatic in 2001. Let’s go back even further to 1984 when mortgage rates exceeded 14%. Given the history of rates over the last 20 years, the answer would have to be “no,” the good times aren’t over yet.

Ok, so let’s look at some reasons you might want to refinance your current home or, assuming you have the financial capability, why you might want to move to a different address now, rather than later.

Assuming you have the need and ability to pay for a new and possibly more expensive home, this is a very attractive time to buy a new home. While on the climb, mortgage rates really are very low compared to the last 20 years. If you home is in a desirable neighborhood, you will likely be able to sell it sooner rather than later and for a higher price. Of course, it’s also possible that the current owners of your dream house down the road are thinking the same thing about price; don’t expect to get off cheap on your move. Still, the current low rates should help offset any increased price.

So much for buying a new home, what about your current mortgage? If all you are interested in is lowering the monthly payment, it’s strictly a numbers game. A general rule of thumb is, “If you can recover the closing costs in 30 months, it’s probably worth doing.” Closing costs are things like loan origination fees, points, title insurance, attorney fees, etc.

Our 30-month rule leads us to the first reason to avoid refinancing. If you plan on moving in two or three years, you probably won’t save by refinancing. Let’s take an example. Suppose you had a home valued at $150,000 and a $94,132 mortgage at 7% due over the next 25 years. If you refinanced now assuming a 5.94% rate and $3,441 in closing costs, your payment would drop from $665 per month to $561, excluding tax and insurance escrow payments. To break even, you would have to stay in your home 33 months to recover the cost of the refinancing. If you plan on moving before then, don’t refinance. If you plan on staying there forever, the refinance would probably be worth it since you are not that far from the 30-month rule of thumb.

Reason number two that might lead you to refinance is to pull equity out of your house. Say you have a really great opportunity to invest in a venture that will bring you a 20% return or you need a new vehicle after your 1977 Chevy Malibu blew up on you, drawing on the equity might be the best option for you. If you are able to refinance and get reduced closing costs through your current lender, drawing on the equity in your home may be your best bet. Remember, unless you have a million dollar mortgage, the interest you pay on a home loan is deductible; personal interest on your automobile is not deductible. By the way, forget this reason if the dealer will give you a zero interest loan.

Are you looking to retire 16 years from now, but your current mortgage still has 25 years left to go? Refinancing may be a way to help you retire with your house paid for. Using that same $94,132 we talked about earlier, but changing the term to 15 years, the payment would go up to $791 per month. Oops, that’s an increase in payment. Can you handle that? If you can, the payment may increase, but total payments will be approximately $142,000 over 15 years as opposed to the nearly $200,000 you would pay on the current loan.

Do you have more than one mortgage on your home? Do you carry high balances on your high interest rate credit cards? If you do, you may want to refinance and consolidate all your debt into one easy monthly payment. Aside from that statement sounding like a commercial, the fact is paying off high rate credit cards through refinancing your mortgage and pulling out some equity could save a bundle. Say that you owe $15,000 on credit cards with an 18% annual rate. To pay the debt off in five years you would have to shell out $383.63 per month over the next five years. Refinancing your mortgage and paying off the credit cards with a 5.94% loan would drop your monthly payments from $1,049 to $917 if you take the 15-year loan. Not only that, but you save $57,500 in interest charges.

A few other reasons you might want to refinance are that you have a balloon payment coming due on your old mortgage or you have an adjustable rate mortgage and you want to lock in the lower rates now. You may also wish to remodel and borrowing against your house will be the least expensive way to get the funds to pay the bill.

Ok, let’s see. I’ve given you a few reasons to refinance and only one reason not to refinance. This is not exactly a reason not to refinance, but it is a warning. Remember we talked about those e-mail offers that our founding fathers keep sending you? Be careful with the people making such offers. In the first place, they may be trying to sucker you in by offering an adjustable rate. Second, you probably know little about them and they could be con artists taking the up front fees and leaving you with no loan. At the very least, you should check the advertiser out thoroughly; some are reputable lenders with a nationwide market. However, you are probably better off going to your original lender first. Chances are they have an offer as good, or at least good enough to keep you doing business with them. Most of the time, you are better off dealing with people you know will give you a fair deal and not someone who won’t be around next year.

If you are thinking about refinancing, take a moment to plug the numbers into our Refinancing Breakeven Calculator. This should give you some idea of the advisability of refinancing. Then, give us a call and we can help you clarify the reasons you may want to enter the world of mortgage refinancing. After all, we’re here to help you make the best decisions for you.

Keep our troops throughout the world in your thoughts and prayers and have a great August.
 

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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