Should I Refinance?

I'm getting a lot of questions lately about whether or not to refinance. I'm looking into it myself, actually, so thought I'd share some thoughts.

First, let's talk about rates and the elusive 4.5% that some government agencies announced, then recanted, as a 'target'. First, that rate may never get here. Second, it may have restrictions around it (like only available to purchases) if it does get here. Third, rates are bouncing really darn close to that number now. Note that the rate also applies only to the conforming limit (currently $417K). "Jumbo conforming" (loans between $417K and $625K) will be higher, and regular "jumbo" above $625K are higher still. (As an aside, if your current loan balance is near one of these breakpoints, you should think about paying the difference down to get into the 'better' loan category.)

So, personally, I'm right on the verge of pulling the trigger. A bird in hand, as they say. Best thing to do is calculate the break even number of months where your closing costs equal the savings in your monthly payment. If you're going to be in the new loan that number of months, then you should seriously think about locking in that savings.

Historically, a rule of thumb is that if rates are 1% lower than what you’re currently paying, you should at least look into it. Remember rates change several times each day, so don’t be surprised if you call one day and then the next day rates are back up again. The decision of whether refinancing makes sense for you -- even with a 1% drop in rates -- can get complicated very quickly given our recent market conditions though.

First thing to think about is the current market value of the home and your equity in it. That’s important because if you got a loan a few years ago, credit conditions have changed dramatically and you may not be happy with the loan options available to you right now, even if the rates are low. For example, if you have two trusts on your current home loan (popular a few years ago in order to avoid paying Private Mortgage Insurance) then that option is no longer available. Banks are requiring private mortgage insurance for anything higher than 80% Loan-To-Value (LTV) – in other words, unless you have 20% equity in your home, you will be required to get one loan and pay the PMI. Second trusts are no longer available in almost any situation. In fact, it’s rare to find a bank willing to lend more than 90% of the current market value of the home, which becomes an issue if your home has depreciated in value. So if you have two trusts it may not be as lucrative for you to refinance as you think, even with lower rates. Similarly, if the home has depreciated at all then you may run into issues as well because your LTV has changed and you will have to pony up some big cash to make up the difference in your "underwater" home.

Let’s take an example: Let’s say you bought a home at $400K with $20K down. Let’s say further that now it’s worth $390K. (The bank will require you to pay for a non-refundable appraisal, which costs about $350-400, to justify the current value of the home before you refinance. And the bank has to choose the appraiser, so don’t bother paying for one on your own and then shopping it around.) The bank may only be willing to lend 90% of that amount (depending on your credit and other factors), or $351K. But you only have $20K equity in the property and still owe $380K. That means in order to finance you have to come up with the difference of $380K-$351K = $29K PLUS your closing costs (similar to costs when you first purchased, and includes county fees, lender fees, title fees, etc.)

Even if your property hasn’t depreciated at all, but the bank’s new policy could very well be to lend no more than 90%, then you still can only borrow $400K * 90% = $360K, leaving you to still come up with $20K (= $380 you owe less the $360 the new bank is willing to lend) PLUS closing costs.

Finally, even if the property hasn’t depreciated, and even if the bank is still willing to lend you 95% of the value—in this example the entire $380K you owe—then your payment still may not be as low as you expect because now you’re required to have a single loan at 95% LTV which requires PMI (rather than your current two trusts at 80% + 15%).

Closing costs can generally be rolled into the loan amount if you have enough equity to meet the LTV requirements. But unfortunately a lot of people will have to come up with significant cash if they want to refinance. But if your property has held it’s value, and/or you have sizable equity in it, then it’s almost definitely worth it to re-fi. So the bottom line is that there are a lot of variables to determine whether or not it’s worth it to refinance. It’s best to talk to a lender to figure out your specific situation. Contact me if you want my recommendations on lenders I would (and do) personally use.

Closing costs, by the way, vary by lender and by settlement company, just like with a purchase. When a lender gives you a good faith estimate, you should focus first on the 800 section “Lender Fees” to see what they’re charging you, and compare that across lenders to find the best deal. Those fees are always negotiable. But banks need to make money too, so don't expect them to charge nothing. Also look at the settlement company fees in the 1100 section, also somewhat negotiable. You do NOT need to use the settlement company the bank recommends. Contact me if you want a recommendation on who I personally would use.

Paying Points: Whether or not to pay points to get a lower rate is a judgment call, and depends on how long you’re going to stay in the property. A point equals 1% of the loan amount. So you might get a quote for 5.125% (no points) and 4.875% (1 point). If you have a $380K loan then that means you pay $3800 at closing to get the 4.875%. So you just calculate the savings in payment, divided by the $3800, and that gives you the number of months you need to keep that loan in order to make it worthwhile to pay the point.

So as you can see there are a LOT of variables in the decision of whether or not to refinance, so the best advice I can give is to (1) have a realistic idea of what your home is worth and (2) talk to a lender. Even if you start down the re-fi road and one of these scenarios ends up being bad news for you, the worst case is that your out the $400ish for the appraisal and you keep your current loan.