Introduction

    There are numerous situations where you as a homeowner may consider refinancing as a way to save money.  Some of the most
    common are:  (I) replacing a high-interest fixed-rate loan; (ii) refinancing an ARM with a fixed-rate loan; (iii) trading an ARM for
    another ARM; (iv) getting rid of private mortgage insurance; and (v) combining primary and secondary financing.

    Replacing a High Interest Fixed-Rate Loan.  Here, a difference in interest rates of two or three percent makes refinancing viable.  
    Even in cases of smaller differentials in interest rates, refinancing may still be worthwhile, depending on closing costs, how long it
    takes to recoup them, and how long you expect to remain in the residence.  For example, if refinancing results in a $100 savings in
    monthly payments, and closing and other costs are $4,800, it will take four years to be in the same economic position as before the
    refinancing.  This, of course, doesn't take into account the lost earning power of the $4,800, or the tax consequences.  Obviously, if a
    move within a few years is anticipated, refinancing may be contraindicated.

    Refinancing an ARM with a Fixed-Rate Loan.  Although the interest on an adjustable rate mortgage (ARM) will drop if the index
    used drops, you may figure you are better off locking in a lower rate by refinancing with a fixed-rate mortgage.  And consider the
    reverse situation:  If you as an ARM borrower have seen your payments go up each time the adjustment period rolls around, you may
    want to cut your losses and refinance with a fixed-rate loan, even if fixed rates are higher than your current ARM rate.  These
    decisions are difficult to quantify.  You should reexamine how the ARM index has fluctuated over time and build a best-and worse-
    case payment scenario.  The present value of the payments should then be compared with the costs of refinancing.

    Trading an ARM for Another ARM.  The first case where you may trade one ARM for another is with a "teaser" ARM.  If you bought
    your home with an ARM with a very low or "teaser" an introductory interest rate, you may be tempted to avoid steeply higher payments
    at the first adjustment period by refinancing with another "teaser" ARM.  This strategy sounds good, but in practice it's tough to make
    it pay off in significant savings.  For example, assume that you bought your home with a $150,000 annually adjustable ARM carrying
    an introductory rate of six percent.  One year later, when the interest rate is scheduled to increase to eight percent, you have an
    opportunity to refinance with another annually adjustable ARM carrying a five percent introductory rate.  

    On its face, the three point difference appears to save about $4,500 over one year.  But refinancing costs a lot.  If the lender is
    charging two points on the new mortgage, this would $3,000, and then there would likely be other costs that would eat up the
    savings.  Finally, the maneuver merely delays facing the inevitable.  One year later, you would have to go through the time, trouble,
    and expense of another refinancing to keep any savings going.  If a "teaser" rate could be found on an ARM with a three-year or
    longer guaranteed fixed-rate period, this savings scenario becomes potentially more appealing.

    The second reason to refinance an ARM for an ARM might be in a situation where you have an older ARM with a relatively high
    interest rate floor.  For example, let's say you bought a home in 1998 with a $150,000.00, one-year ARM.  It is probable that ARMs
    from that period have a interest rate floor of five percent or higher.  In such a case the ARM interest rate will not have gone below the
    floor of five percent, in spite of the fact that using the ARM calculations it would otherwise have been lower.  If you can refinance,
    lower your initial interest rate, and lower the floor for future adjustments, you would be protected against substantial increases in the
    interest rate in the longer term future, and be able at the same time to take full advantage of lower-rate adjustments.

    If you are inclined toward refinancing with an ARM, you should thoroughly review the various loan products available from your
    lender.  Some ARMs are less volatile than others, owing to the use of more stable indices by which interest rate changes are
    determined.  Also, you will find that there is a much wider variety of indices and ARM options from which to choose today than just a
    few years ago.

    Getting Rid of Private Mortgage Insurance.  Private mortgage insurance, or PMI, which often adds $50 to $200 onto homeowners'
    monthly mortgage payments, is required by most lenders whenever a borrower obtains a loan with a loan-to-value ratio of less than
    80 percent.  PMI protects only the lender - or the ultimate buyer of the loan, like Fannie Mae - against financial loss in the event of a
    borrower's nonpayment of principal and interest.  Should a borrower default and the house go to foreclosure, the PMI policy pays the
    lender's loss to some specified level of coverage and many lenders do not permit the cancellation of PMI.

    After considerable action in Congress in recent years, it is now mandatory for a lender to allow termination of PMI at the request of the
    borrower when certain conditions have been met.  Generally, when loan-to-value ration reaches 78% and the loan is in good standing
    and seasoned, that is one-to-three years old, PMI can be removed at the request of the borrower.  It is also mandatory, in most cases,
    for a lender to automatically remove PMI when the loan has been paid down to 78% of the original amount.  Many homeowners who
    have acquired an equity position in their homes of 20% or more through appreciation or property improvements may be able to
    remove PMI only through refinancing.

    If you refinance to remove PMI, you need to calculate the savings you will experience through removal of the PMI premium and the
    savings you receive through a lower interest rate to determine whether refinancing is advisable.  As a general rule, if you can lower
    your interest rate by at least one and one-half percent while eliminating PMI, refinancing will be cost-effective.

    Combining First & Second Trust Loans.  In recent years, many home buyers have financed their purchases using a combination of
    primary and secondary financing, or first and second mortgage loans.  This has become a very popular alternative to a single
    mortgage at 90%-95%.  In such a case, the buyer would secure an 80% first trust loan and a 10%-15% second trust loan, and thus
    avoid PMI expenses.

    In those instances where equity has grown, through appreciation or improvements, refinancing to combine two loans can be a real
    money saver.  This could even be the case where the secondary financing was not secured in conjunction with the purchase–maybe
    taken out later as an equity loan to buy a car or for other purposes.

    Most secondary financing loans carry a higher interest rate than primary loans.  Combining the loans into a single amount with a lower
    interest rate could save hundreds in monthly payments, and thousands in long-term payments.

    Costs of Refinancing

    Unless the mortgage has a built-in refinancing option, the closing costs associated with refinancing are almost the same as those
    charged on an original mortgage; however, most items which are deductible for Federal and State income tax purposes on a
    purchase are not immediately deductible on refinancing.  A list of the most common costs of refinancing follows:

  • Points: Rarely seen anymore, but when used, usually called loan origination or discount fees, one point equals one percent of
    the loan amount.  Points often are the biggest expense in refinancing.  If the payment of points is only for the use of money and
    not for any specific services, it is interest paid in advance and under the Internal Revenue Code a tax-deduction is available,
    when the debt is secured by one's residence.  If refinancing is for current improvements, certain educational expenses or
    medical expenses, the points may be deductible in the year in which paid, otherwise they may be deducted over the life of the
    loan.  Finally, Where points clearly will not be deductible, instead of paying them out of pocket, you may want to consider
    financing them by adding them to the amount borrowed.  Your deduction of the points could then more closely match your costs
    in paying them during the term of the mortgage.
  • Application fee:  Some lenders charge a non-refundable fee that is paid up front and is not returned even if the loan is denied.  
    The fee, which may run to several hundred dollars, may encompass an appraisal of the home and a credit check.
  • Survey:  A lender may require a new property survey or a survey update or re-certification; however, most lenders accept an
    affidavit from you as the homeowner that there has been no change to the property improvements or boundary since the last
    survey.  A new survey will cost approximately $250-$750, while a re-certification or an update will cost $175-$250, if one is
    needed.
  • Title insurance:  Despite the fact that the property is not changing hands, the lender will require a new mortgagee title
    insurance policy for the new loan.  Refinancing loan policies cost 70% of the original issue loan rate, beginning at $2.03 per
    $1,000 of coverage up to $500,000.
  • State and local recording taxes:  These are nondeductible taxes.  The amount depends on the size of the mortgage.  In
    Virginia, the combined State and local tax is $3.34 for each $1,000 of the new mortgage.  If refinancing an existing mortgage
    loan, regardless of the balance, you are taxed at the reduced combined rate of $2.40 per $1,000 of the new mortgage.
  • Attorney's fees:  You must pay attorney's fees, or a closing fee to the settlement agent conducting the closing on the new loan.  
    This will generally be a few hundred dollars.
  • Prepayment penalty:  The existing mortgage and applicable law must be checked for a prepayment penalty.  If there is one, it
    may be deductible for income-tax purposes if it takes the form of an interest penalty.
  • Cost of repaying secondary financing:  If you carry a first mortgage and a second mortgage or home-equity line of credit, a
    lender refinancing the first mortgage may require you to pay off all secondary financing.  In many cases, depending on the type
    of loan sought, lenders will accept a subordination agreement whereby the secondary financing stays in place but is
    subordinated to the new first mortgage.  If the secondary financing must be paid off, it could cause a temporary cash flow
    problem, and the costs to re-establish a home equity credit line or subordinate the secondary financing must be considered as
    part of the refinancing costs.  These costs usually do not exceed $200-$300.  If you intend to keep secondary or equity
    financing in place, check with your equity lender regarding its procedures and time requirements for subordinating its loan to
    your new first mortgage.  Some equity lenders charge a fee to subordinate their interest, so check that as well.
  • Miscellaneous costs:  The lender may require certain inspections of the property, such as an update of the termite inspection,
    inspection of a well and septic system, or a flood-zone certification; interest on the new loan is usually collected at closing from
    the date the loan is funded to the end of the month; and, there may be other costs, such as courier charges, title commitment
    fees and title abstracting costs.

    Closing costs, including points, can amount to as much as five percent or more of the loan itself.  However, to the extent that the costs
    are tax-deductible, the burden is eased somewhat.  

    Nondeductible items generally increase your tax basis in the home and thus may reduce gain on ultimate disposition or resale.

    Loan Processing Time

    It can take as much as 60 days from application to secure a loan commitment and 60 to 120 days from application to closing.  These
    time frames are only averages and actual time may vary widely among lenders and settlement agents.  Another timing factor is the
    question of when you lock into a particular rate.  

    Some lenders lock in the rate upon commitment, others not until the closing.  Some lenders lock in the rate upon application for a set
    period.  Some give borrowers the option of locking in the rate prior to closing by paying a fee, such as an additional point or half point
    added to the refinancing costs.

    Time to Recoup Costs

    The following chart indicates how many months it would take to recoup specified dollar amounts of refinancing costs for specified
    decreases in monthly payments.
    To use the chart, look across the top of the chart for the number which most closely approximates the expected decrease in monthly
    payment that would result from a proposed refinancing.  Next, at the column on the left, locate the dollar amount that is closest to the
    actual costs of refinancing.  Now find the number in the intersecting  box.  This is the approximate number of months it will take to
    recoup the costs of refinancing.

    When calculating the actual costs of refinancing, remember to consider the fact that you will probably miss at least one payment on
    either the old or new loan as part of the refinancing.  This occurs because you will pay interest on the old loan as part of the payoff
    and will not make your first payment on the new loan until the first day of the first full month following closing on the new loan.

        















    Use the following loan calculator to determine your monthly payment for various terms and interest rates.





















    Also, when calculating the actual costs of refinancing, consider that even though you may pay money at closing to start new escrow
    accounts, you will be refunded the balance in old escrow accounts from your old loan.

    There is usually a net expense of one additional month of escrow deposits as part of refinancing - to cover the month for which you
    will not make a payment on either loan.

    Arguably, however, escrow deposits should not be considered when determining your actual costs of refinancing.  In either event, you
    should check with the new lender about the possibility of waiving the escrow deposit requirement if you desire to pay the escrow items
    (e.g., taxes and insurance) directly.

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    Potomac West Title
    9316-A Old Keene Mill Road
    Burke, Virginia 22015-4285
    703-584-7744  (F) 703-584-7746
    lmartin@pwtitle.com
PotomacWestTitle
Professional Real Estate Closings
Refinancing Your Home Mortgage
PotomacWestTitle
9316-A Old Keene Mill Road
Burke, Virginia 22015-4285
703-584-7744
(F) 703-584-7746
lmartin@pwtitle.com
Actual Costs
$100
$200
$300
$10,000
75
37 1/2
25
5,000
50
25
16 2/3
2,500
25
12 1/2
8 1/3
1,000
10
5
3 1/3
500
5
2 1/2
1 1/2
Decrease in  Monthly Payment/Months Needed to Recoup Costs
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