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How many times over the past several years have you heard, “mortgage rates are at historic lows and the time to refinance is now?”  We have been flooded by a barrage of recent advertisements promising low mortgage rates making it quite easy to become immune to those claims.  In fact, one morning this week on the way to work I heard a radio commercial by a mortgage company indicating that mortgage rates were currently at the lowest point in five decades!  And while I was certainly aware that mortgage rates had recently ticked down again, my curiosity was sparked to find out how low we really are relative to history.

I did some research on the web and learned that the 30-year fixed rate hasn’t been as low as it is currently since the 1950s (and back then longer-term mortgages generally extended only for 20-25 year periods).  Given current conditions, I have been busy assisting a number of clients through the refinancing process.  Here is an indication of just how low rates are today (as of August 4, 2010):

  • 10 Year Fixed  = 3.875%
  • 15 Year Fixed  = 4.0%
  • 30 Year Fixed  =  4.5%

And while rates may truly be at historically low levels, that doesn’t necessarily mean you should refinance your current mortgage.  First and foremost, it is important to understand what your refinancing goals and objectives are before you plow blindly ahead.  Some common reasons people refinance include:

  • Desire to move from a variable rate mortgage to a fixed rate (peace of mind)
  • Save money (by reducing interest cost)
  • Debt consolidation
  • Take cash out for a specific expenditure
  • Shorten the loan payoff period

Some other factors to consider as you contemplate refinancing are issues such as:

  • Closing costs
  • Length of time it will take to recover the closing costs
  • Whether or not there are points to pay
  • What will the home appraise for today (given the decline in home valuations)?
  • How long are you planning to stay in the home?
  • Impact on extending or resetting the amortization period

Also, keep in mind that the process of refinancing does take some effort.  As a result of the recent financial meltdown we experienced, lending standards have become more rigid.  Having just experienced this process with a client, I now know that most lending institutions are requiring the following documents from borrowers:  last two years of tax returns, most recent W-2 income tax form, earnings stubs, investment account statements, bank statements—and they are looking at your credit score with more scrutiny than ever.

To help you understand the decision-making process that characterized an exchange I had with a client this past week, I share the following information:

Original Loan:

  • Original Loan Amount = $400,000
  • Loan Initiated August 1, 2003
  • Term = 30-Year Fixed
  • Rate = 5.75%
  • Monthly Principal &Interest Payment = $2,334.29

Current Situation:

  • Current Loan Balance = $356,934
  • Seven years into the 30-year amortization
  • No plans to move
  • Desire to lock in at 4.5% on a 30-year fixed rate

Questions/Considerations:

Question #1:  How much would the monthly principal and interest payment drop if you refinance?

  • Answer: $525.76 (From $2,334.29 down to $1,808.53)
  • Comment: While the monthly cash flow improves significantly, the term of the loan has been reset back to 30 years, which may not be desirable.

Question #2:  As part of the refinancing process, what if you decide you do not want to extend the term of the loan and prefer  to maintain a 23 year amortization?  Specifically, how much would you have to pay per month?

  • Answer:  $2,078.14 (improves monthly cash flow by $256.15)
  • Comment:  By refinancing and maintaining the same amortization schedule, interest savings would amount to $70,697 over the life of the loan.

Questions #3:  What if you refinance and continue to make the same principal and interest payment ($2,334.29) that you are making on the original loan? How quickly will the note get paid down?

  • Answer:  Approximately 19 years (reduces amortization by four years)
  • Comment:  By refinancing and maintaining the same payment, the interest savings would amount to $112,964 over the life of the loan.

As is apparent in the scenario outlined above, refinancing this client’s home makes good financial sense.  For those of you that haven’t reviewed your mortgage situation lately, this truly may be one of the most advantageous times in history to look into it based on today’s rate levels.  I know your Moneta Family CFO would be happy to have that dialogue with you.

bio-ring-matt

Matthew D. Ring, CPA, CFP