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March 27, 2006

Should I Refinance My House?

Even after several years of historically low mortgage rates, I still hear from folks who are considering refinancing their homes.

It's a big decision; there's no doubt about that. It's big because it can have a huge, long-term effect on your family's wealth (or lack thereof). Refinancing isn't cheap, for one thing. The lending fees and closing costs alone likely will zing your net worth to the tune of more than a thousand dollars.

But if you're someone whose home is currently financed with an adjustable-rate mortgage (ARM, for short), and you're looking at the prospect of hefty payment increases down the road, thanks to the rising interest-rate environment we're currently in, then the closing costs associated with refinancing to a fixed-rate loan may be small peanuts in comparison. CNN/Money tells us that roughly a third of all mortgages initiated in the 2002 through 2005 period were ARMs.

For these homeowners, those lower initial payments were sweet. But now interest-rate reality is setting in: From here on out, each one-percentage-point move upward in mortgage rates will increase their payments by more than ten percent. Which usually translates into extra hundreds of dollars per month.

Here's an example: If you ARM-financed $300,000 for 30 years at 5 percent, your total payment (principal and interest) would be $1,610.

Suppose your rate adjusts to 7 percent. You still owe $285,612, and your payment term is now 27 years. Guess what? Your monthly payment just inflated to something near $1,991. That's an increase of over 23 percent, or $380 per month. Not miniscule, to be sure. And if your property taxes have increased, too (which is a fair proposition), then your monthly budget probably just redlined.

Items like this ABC News foreclosure story are only going to become more common, I'm afraid. In that regard, I'd like to thank the guys at MortgageLoan.com for offering the following article, which touches on all the angles one must consider when he or she is contemplating a mortgage refinance.

Hopefully this will give readers a better idea of all the factors involved!

Article courtesy of MortgageLoan.com

Consider This Before Refinancing
Refinancing a mortgage is dependent largely on one’s personal financial situation. There are several mortgage options available in the market today. It is advisable to first evaluate each option before taking a decision. If the right option is unavailable, it sometimes better to forgo the refinancing altogether.

Below are some important points that merit some consideration while debating a refinance option:

Funding and Fees
Refinancing a mortgage will require that you have sufficient funds to take care of up-front costs and fees. If you do not have adequate funds to pay for these initial costs, it may be possible to finance these costs by adding them into your mortgage, should you decide to take one. This results in slightly higher monthly costs, as your mortgage becomes larger with the fees included.

Recovering the costs
Refinancing costs and fees are typically recovered within 2-3 years. Hence, if you are thinking of selling your property before then, or paying off the loan within a short duration, then refinancing is probably not suitable. There will be insufficient time to recover your initial costs. However, this also depends on the amount of savings you will have with the new mortgage, as well as the amount of up-front costs.

Income Levels
Another factor to take into consideration is your income. If your income has increased significantly, then the chances of you being able to afford higher monthly payments will be higher, and help you to decrease the term of your mortgage. If the existing interest rate is lower for a shorter mortgage term than it would be for a longer-term mortgage, then refinancing is a good bet. Otherwise, it is better to just make larger principal payments against your current mortgage.

Adjustable Rate Mortgage (ARM)
If the existing interest rates for a fixed rate mortgage are the same as (or little higher than) the Adjustable Rate Mortgage, then refinancing can be justified. If the fixed rate is lower than it is anticipated to be when the ARM changes over to a fixed rate, then you might also strongly consider the refinance option.

In short, it is important to thoroughly think through your refinancing options. It should be re-examined periodically by considering changes in your financial status, as well as those due to fluctuations in the economy. You may find that deferring your refinancing option for a later time can save you considerable money.

Courtesy of MortgageLoan.com | March 27, 2006

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IYM Article (2002-08-30): Home, Expensive Home
IYM Article (2004-08-22): Not Big on Bach
IYM Article (2005-07-24): David Bach and Budgeting
IYM Article (2006-03-05): David Bach and Mortgage Math

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