Even recent borrowers can save money by refinancing today
The prolonged drop in mortgage rates has made it worthwhile for many homeowners to get a new loan, even if they have refinanced in the past few years.
Q. We saved a lot of money when we refinanced our 30-year mortgage at 4.6 percent two years ago. We would like to refinance again because rates are about one point lower, but we have always been told it doesn't make sense to refinance unless our new rate would be at least two percentage points lower than our current rate. Is this true?
A. No. Thanks to changes in the lending industry in the past several years, that old rule of thumb that says you shouldn't refi unless your new rate would be at least two points lower than your current one has gone the way of Dodo birds and polyester leisure suits.
Millions of homeowners who refinanced when fixed 30-year loan rates dropped below 5 percent a few years ago are doing it again for the second or third time — or, at least should be thinking about it. I'm devoting this entire column to answering some of the most common questions.
Q. How do I know if refinancing would make sense for me today?
A. The three most important considerations are how much you would save each month by refinancing at today's rates, how much the lender would charge to set up the new mortgage, and how much longer you expect to stay in your home.
Let's say that you bought your home or refinanced with a 30-year fixed-rate loan for $200,000 two years ago, when rates averaged about 4.6 percent, according to rate tracker bankrate.com. Your monthly payment for principal and interest would be $1,025.
Today's fixed rates are about 3.5 percent, which would slash $127 off your monthly bill, but the lender also would want to charge one "point" (1 percent of the loan amount, or $2,000) plus $600 in other fees. Your total refinancing costs would be $2,600.
If you divide the $2,600 cost of getting the new loan by your $127 monthly savings, you would end up with a figure of 20.4. That means that you would need to stay in the house for at least 20 months for your savings to offset your costs. After that, you'd be in the black.
Should you plan to move in less than 20 months, you probably should forget about refinancing unless fixed mortgage rates drop even farther or you are willing to consider other loan alternatives.
Q. What "alternatives" are there?
A. There are several, the obvious one being an adjustable-rate mortgage, with an interest rate that will fluctuate in the future. Introductory rates on ARMs today are almost exactly one percentage point lower than rates on fixed mortgages, which would lower your monthly payment by a total of $224 on the $200,000 new loan and would allow you to recoup your upfront costs in only 12 months.
Of course, interest rates on most ARMs are adjusted on a monthly, semiannual or yearly basis. They might be a good choice if you plan to move in a year or two, before the rate can ratchet much higher.
If the thought of having a rate that will change relatively often would keep you awake at night, a good compromise might be a so-called "5/1" or "7/1" loan. You'd still get a below-market rate to start with, but the loan would adjust only once — in five or seven years — and then convert to a fixed-rate loan for the rest of the 15- or 30-year term.
Q. Are there any loans out there that don't require upfront fees and points?
A. Yes, although you might have to make several calls to banks and mortgage brokers to find one, and you likely will be charged a higher interest rate over the course of the mortgage. But your very first call should be to your current lender: Many financial institutions are waiving or reducing their fees for their current borrowers who want to refinance.
Q. What kind of paperwork will the lender need to see?
A. Requirements vary from one bank to the next, but nearly all of them are demanding much more documentation than they did just a few years ago. Expect to be asked for at least one recent pay stub that shows your year-to-date earnings, two or three recent bank and brokerage statements, and two years of your annual W-2 forms.
If you're self-employed, also plan on providing the bank with your last two tax returns and perhaps even an updated profit-and-loss statement.
• For the booklets "Straight Talk About Living Trusts" and "Refinancing he Right Way," send $4 for each and a self-addressed, stamped envelope to David Myers, P.O. Box 4405, Culver City, CA 90231-4405.
© 2012, Cowles Syndicate Inc.
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