Refinancing is fun!
Dec 30 '05 (Updated Feb 03 '06)
The Bottom Line -
Refinancing for dummies!
The sub–category that this essay calls home is titled ’What is a Refinance?’ So let’s start with our old friend Webster…
Refinance – To sell securities in order to redeem (existing bonds or other indebtedness or preferred stock).
Wha…?
Okay, I’m actually a little disappointed with Webster’s short entry on the word. My own working definition of the word would be…
An intransitive (or transitive, depending on sentence context) verb referring to the act of obtaining a new Mortgage for the purpose of paying off the extant Mortgage on the same Real Property. It can also be a noun, as in – ’How’s that refinance coming along Billy–Bob?’
Now that we’ve answered the question posed by the category heading I have some random thoughts to share about refinancing. I’ve been in the Mortgage Industry for 15 years but by no means do I consider my perspective to be the end–all truth on matters of finance. Research as much as you can and fit the knowledge to your own unique circumstances. And with that disclaimer made, let’s talk about some refinacin’ stuff.
Very few people have the ability to buy a house (condo, co–op, etc) for cash. Those who do have that kind of cash are likely not to anyway because mortgaging a property provides a rather useful tax shelter. So given the fact that nearly all homeowners will be dealing with a mortgage, it’s important to understand that you are not locked in to that Note for the long haul. You can (and most people do) refinance at some point. Indeed, the life expectancy of 30 year mortgages has dropped from 7 to 5 years over the past decade. With all this shuffling of paper it’s imperative to understand the whys and hows of the process.
Why in the Sam Hill would I want to go through that again?
The most obvious reason is rate reduction. Rates have been dropping steadily for the past thirty years. I’m not talking eighths here – I mean dropping from 20 percent to 6 percent on average, over time. As rates drop you can refinance to lower your payment even if your credit and other factors haven’t changed.
Terms are another popular reason. If you find yourself navigating an unexpected financial setback you may need to extend the term (ie; from 15 years to 30 years) in order to lower your payment.
Then there’s the always popular "I want cash out" motive. A myriad of reasons for this exist. Maybe you want to do some home improvements. Maybe you want to invest in a new business or buy a new car. Perhaps Junior stunned you with a college admission letter and now you’re scrambling for tuition money.
So the ’why’ is easily explained. Refinancing has great benefit for many, many reasons. The ’how’ requires a great deal more thought than the ’why’. Recent (past decade) developments in the Mortgage Industry have made the ’how’ even trickier. You really need to scrutinize this and make sure the path you choose will not have costs that outweigh the benefits.
What’s this ’First Born’ clause all about?
Be careful what you agree to. The mortgages of today may be very different from the one you are refinancing. The first step in this process is choosing your path – and as I see it you have three distinct avenues. You can refi directly with a bank, you can enlist the services of a broker or you can use an online lender.
Starting with online lenders…I don’t personally like them. They have good and bad products like anyone else but their staffs are not well trained for the most part and they don’t service their paper. They’re (I think all) acting as Correspondent Lenders. Some, like Ditech are direct conduits and some, like Lending Tree are simply referral sites where lenders buy applications. Overall the experience is usually not personalized and I question if the applicants best interests are ever considered. There’s a perception that reduced overhead is passed on to the consumer but that’s a carefully crafted misconception. All mortgages, online or not, are replete with embedded fees. Some you can see, most you can’t. There is no such thing as a no–cost mortgage, and the online mortgages have as many fees as the traditional mortgages. For personalized service I would go to a Bank or Broker.
Going directly to a bank makes a lot of sense for most people. A loan officer will hold your hand through the process and advise you on several scenarios that you can choose from. It’s usually best to use a bank you’ve done business with but that’s not always the case. The recent trend of Pre–Payment Penalties being attached to mortgages is a potential deal breaker for a lot of applicants. Your lender will NOT just "let it go." Actually, they can’t. If the PPP is in effect it probably means the loan hasn’t crossed that magic line from red to black in the lender’s portfolio. However the lender often will disregard the PPP if you agree to refinance with them again. There’s nothing wrong with this scenario assuming they are offering you similar terms to whatever you were promised elsewhere. In fact it’s almost always wise to give your current lender a shot at your repeat business. They may be willing to underbid the competition if you have proven yourself a good payer and reduced closing costs are virtually guaranteed.
Those that used a Broker to get the mortgage they are now refinancing will usually need to either refi with their current lender or go back to the Broker again – unless their scenario has greatly changed since they used the Brokerages services the first time of course. Brokers are also the way to go if you know you will need ’creative’ financing or if your credit score is below 620. The most personalized service available will always be from a Broker. Also important to consider is the fact that when you go to a Broker they will be knowledgeable of loan products from many (about 30 in my case) lenders. When you go directly to a bank you’re only being shown what they have on the menu.
So that’s the why and hows of it all. But there’s more. You should be aware of what to expect. Assuming you’re not refinancing with your original lender you’ll be starting from scratch again. An appraisal will need to be ordered. Title needs to be abstracted again and all the income, insurance, and–so–on documents need to be gathered up one more time. Generally a refinance will go smoother than the purchase money mortgage went. All those fees will be paid again – with possible reductions of lenders fees if you stick with the same bank and if the loan you are refinancing is less than a year old the title insurance will likely be a little cheaper, but then you run into that whole pre payment penalty issue.
Some pitfalls to watch out for
Of course there are many downsides to refinancing. The most obvious being that whatever time you spent climbing up the interest burdened end of the amortization will now be repeated by you. You have to factor all that interest into the equation if you’re doing this to save money. Lower payments do not always equal money saved.
Then there’s always those who pull money out of the house for investment and lose it. Kinda sucks having to pay off a bad investment for 30 years.
Weird, new mortgage products must also be scrutinized carefully. The craze for lower and lower rates has more people insisting on adjustables when logic dictates that this is the time to take a fixed loan. Making it worse is the constant advertising of mortgages ’as low as 1 percent’. Have you ever wondered how that’s possible? In short, it’s not. Those ever–so–trendy one percenters are actually interest only notes at the industry base, lets say around 6 percent right now, but for the first three years you only make payments as if it’s one percent interest. Can ya guess where that other 5 percent of interest is going? It’s getting tacked on to the principal balance (which is why one percent loans are only approved for loans up to 80 LTV {loan to value}). So if you take out a 100K loan ’interest only’ one percent, your principal balance after 3 years would be 115K. It’s a bad product – stay away from it. Negative amortization in any form is suspect.
So there you have it. A refinance is paying off one mortgage with a new one and you now have some food for thought if you’re about to travel this road. Ask lots of questions and don’t sign anything you’re not a thousand percent sure about.
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