| A great deal of negative publicity has surrounded the | | | | account. These should not be considered part of the |
| subprime mortgage lending market over the past nine | | | | cost to refinance as they effectively replace costs |
| months. As a practical matter, most of our readers | | | | that will be borne under the current mortgage anyway. |
| enjoy fine credit histories and borrow in conventional | | | | They are usually listed below the Estimated Closing |
| markets. The Federal Reserve has been lowering their | | | | Costs and can be ignored for the purposes of the |
| target rate on short term lending in an effort to quell | | | | cost analysis of the refinancing decision. |
| turmoil in the credit sector. This has had some effect | | | | Only the Loan Origination fee (801) and loan discount |
| on mortgage interest rates as well - possibly opening | | | | (802) are tax deductible. The balance of the closing |
| up refinancing opportunities for borrowers with good | | | | costs are not. This is an important consideration as the |
| credit. This article will focus on the issues to be | | | | borrower is making an after tax investment in closing |
| weighed in any refinancing decision. | | | | costs to obtain savings in mortgage interest - a |
| Different borrowers, of course, are taxed differently. | | | | tax-deductible expense for most. The GFE also lists |
| The degree to which mortgage interest is offset by | | | | the size, interest rate, and term of the loan. We can |
| tax savings varies considerably. As such, this review | | | | use this data to create the comparison with the |
| can only serve as a guideline and is not definitive as to | | | | existing mortgage. As a rule of thumb, it is not worth |
| everyone's particular situation. The advice herein should | | | | undertaking any breakeven analysis unless proposed |
| apply approximately to most borrowers, however. | | | | interest rates are at least 0.50% lower than the |
| When a prospective borrower applies for a new | | | | current mortgage. There may be some jumbo |
| mortgage, the government requires that the lender | | | | mortgages that merit consideration earlier because |
| provide a "Good Faith Estimate" (GFE) within three | | | | many refinancing costs do not increase |
| days of the application. This document sets out all the | | | | commensurately with the loan balance. |
| costs associated with the mortgage. Properly | | | | Here is a real world example. John and Jane Doe |
| identifying the costs of closing a mortgage is a key | | | | currently have a 6.75% mortgage with a $200,000 |
| prerequisite of any refinancing decision. | | | | balance and 26 years remaining. Monthly principal and |
| Mortgage lenders often tout recent Fed interest rate | | | | interest payments are $1362. The Does visit a |
| cuts as incentive to refinance in theirmarketing efforts. | | | | mortgage lender and receive a CFE identifying $3200 |
| Despite this accommodative fed policy, the | | | | in estimated closing costs. It's a 30 year fixed rate at |
| conventional mortgage market has been rather | | | | 6.00%. We'll assume that they are taxed at a 30% |
| choppy over the past 12 months. The data in the | | | | marginal rate. Is this a good deal? The first step is to |
| preceding chart, compiled by Bankrate.com, describes | | | | estimate the annual interest savings each year. The |
| a precipitous decline in the yield of a one year treasury | | | | mortgage is constantly amortizing but we can infer |
| bill. However, both adjustable and fixed rate | | | | that the first year's interest savings will be about (.0675 |
| mortgages, followed a more circuitous path over the | | | | -.0600) * $200,000 = $1500. After taxes, that amounts |
| same period. | | | | to a savings of $1050. This rate will of saving will |
| Keep in mind that mortgages represent longer term | | | | decline somewhat in successive years as the |
| lending. Implicit in these longer term interest rates are | | | | mortgage amortizes. We can conclude that the Does' |
| inflation expectations and liquidity concerns within the | | | | initial "investment" will be recouped after 3 years. |
| mortgage market. In short, the decline in the federal | | | | If we factor in the time value of money, the real |
| funds has not translated directly to lower mortgage | | | | breakeven point moves out closer to five years - |
| rates. There will be opportunities for families to | | | | when they will earn a 17% return on investment. That |
| refinance in 2008. In some cases, the opportunity will | | | | is, the Does stand to benefit from refinancing if they |
| arise from an improved credit standing. Some folks will | | | | plan to stay in their house at least another five years. |
| have seasoned mortgages from past years that might | | | | The following table displays in greater detail the |
| benefit by locking in a sub 6% interest rate available | | | | economics of the refinancing decision. The green rows |
| today. | | | | at the bottom of the illustration indicate the holding |
| The key factor in the refinancing analysis are the | | | | periods over which the Does benefit from refinancing. |
| underlying costs. There are a number of fees | | | | The last topic to be addressed is perhaps the within |
| associated with a new mortgage - many of which | | | | the framework of the refinancing decision. Does the |
| decline in importance with the size of the loan. That's | | | | borrower pay points to buy down the loan interest |
| where the GFE comes in. The fees in the GFE are | | | | rate? These "points" are considered tax deductible |
| organized under numerical headings: the 800s, 900s, | | | | over the life of the loan and are represented under |
| 1000s, 1100s, 1200s, and 1300s. For purposes of | | | | items 801 and 802 of the CFE. Borrowers can typically |
| comparison-shopping, the most significant fees are | | | | write off any unamortized points if the loan is paid off |
| listed in the 800s. Most of the items are within the | | | | via another refinancing or sale. Thus, the tax treatment |
| control of the lender or broker, so the estimates should | | | | of points and mortgage interest is similar enough to be |
| be accurate. A few of the items in the 800s are | | | | ignored for the purpose of breakeven analysis. |
| charged by third parties. These items may not be | | | | As a general rule, every point paid lowers the |
| negotiable but, at least, the lender's estimates should | | | | borrower's interest rate by 0.25%. More simply, every |
| not be far off from the actual charges. | | | | dollar paid up front saves almost $0.25 each year |
| The lender has direct control over origination and | | | | thereafter. The value of the buydown, then, is |
| discount points and fees (listed in 801 and 802) and | | | | governed by how long the new mortgage stays in |
| administrative, underwriting, processing, funding, | | | | place. When the time value of money is considered, |
| document preparation, wire transfer, and other fees | | | | the borrower should plan to stay at least six years to |
| (listed in 810 and higher). These are the fees that are | | | | obtain a good return on the points paid. |
| the best candidates for negotiation as they are set by | | | | The best mortgage to compare from a lender is one |
| the lender and are not contracted out. Keep this in | | | | with no origination fee and discount. That's the one to |
| mind as you are not strictly a price taker when it | | | | ask for first. It makes it easier to value the proposed |
| comes to borrowing - especially if you have good | | | | loan against the current one. If the proposed loan |
| credit. In short, the fees under headings 800, 1100, | | | | passes muster, then the payment of points should be |
| borrower and are summed as Estimated Closing | | | | considered. If a proposed loan grades as barely |
| Costs. This is probably the most important figure on | | | | passable, it's usually better to wait. Once you exercise |
| the form. | | | | the option to refinance, you are effectively precluded |
| Notably, items under the 900 and 1000 heading are | | | | from refinancing again in the immediate future. Don't pull |
| prepaid expenses such as mortgage, hazard and flood | | | | the trigger unless you are getting an excellent return on |
| insurance premiums, mortgage interest and taxes that | | | | investment. |
| must be paid up front or deposited into an escrow | | | | |