Take a philosophical view of "credit" and the answer will become clear. The principal would have been the money you would have needed pay for the house if you had the cash, and the interest is just the penalty you are paying for borrowing it from another entity. So anything that would reduce your interest is your gain. So see credit as a punishment.
If you pay-off your principal (or portions of it) quicker, and in turn if it reduces your interest rate--pat yourself in the back thinking you've become "richer" and acted a little more like a rich man who has the cash. At least you reduced your penalty.

We take credit (esp. auto loans and mortgages) because we don't have the necessary savings or cash flow at that point of time in life to buy some necessary assets. But had we had the money in the first place--we wouldn't have opted for credit, right?

I think in some cases, simple philosophy helps rather than doing a Discounted Cash Flow of estimated earnings and then taking a decision.

posted February 18, 2008

Shop around! See if you can get a better rate. If not, then use the deal your bank is offering.

posted February 18, 2008

Take the savings between your current payment and your new payment (say saving $200 per month) and divide that into the cost of 1% (or 1 point) and that will tell you how many months before you begin to save money. If cost to refinance is $2000 for $200,000 loan and you save $200 per month then you begin saving money in 10 months once you have saved back the cost of the loan. If you plan on owning the home longer than this take the deal, if not seek a cheaper option.

posted February 20, 2008

Uh, what about the opportunity cost of the money you take out of other savings or investment accounts to make the 1% "down payment"?

Obviously the investment markets are in turmoil, so if you are selling at at a loss to raise the "down payment" what have you gained in the long run?

Presumably you would take the difference between the new payment and the old payment and invest that amount back into where you took the "down payment" So the arithmatic tells me my out of pocket cost is the same, irrespective of how much of my payment goes to principle, interest or repaying the "down payment". The increase in wealth comes from the appreciation of the assets -- The house will not go up in value any faster or slower if there is a lower mortgage amount. Likewise the account where the "down payment" came from doesn;t go up or down further or any more frequently if there is less or more money in it. The only difference is the wealth creation -- less money in the investment account means less potential terminal wealth, paying off the mortgage faster does not make the house more valuable any faster.

Thats the numbers side of it. Most answers here deal with the feelings side of it -- the feeling of being debt free or eliminating some sort of borrower's penalty. I pay a non-farmer penalty everytime I buy milk or beer too, but no one suggests I buy a cow or brew my own stout.

You may well want that feeling of debt free etc or you may opt for wealth creation -- you just need to separate the two and make a decision as to what is most important.

Oh and by the way you can do both, just make an extra payment once a year and you'll probably cut 10-15 years off the mortgage term and keep your "down payment" money invested for long term wealth creation.

Hope that helps more than a little.

posted February 20, 2008

Always shop around business to competitors.

Who competes with your bank.

Get your income and credit score maximized,
and shop around!!! You might be very surprised!!!

posted February 23, 2008

Anant,

I get this question a lot, it is wise to be skeptical; many would just jump right in and say “A lower rate? Sure!” And given the current foreclosure activity, it only makes sense these days, to most people, to get out of their adjustable rate mortgages immediately. But is this the right thing for you? For right now? Let’s look…

Banks don’t do charity, if they are calling you; there is something in it for them. One or more of the following reasons probably applies to your situation prompting this solicitation.

-Timely payments, yours is likely a well performing loan. Banks care about their portfolio in size AND quality.

-Retention, You have probably been in your current mortgage between 24-48 months which is a refinancing sweet spot so they would rather make less money off of you than none at all.

-Money, A bank will always want to keep you in the early stages of a simple interest loan because of it’s tremendous rate of return in the first few years. See this scenario…

Ex: Say $200k @ 6.875% @ 360 mos. = $1,314 P&I pmt that you have made for 36 months means that you have paid $47,268 in pmts and have reduced your balance only $6,697. The bank just made over $40k off of you. They like this math and want to do it again, even if their rate of return is a bit lower at say a 5.375% rate

*** For the rest of this analysis keep in mind that; 1st, I have to use average terms as you did not provide your personal details (nor would I), 2nd, I have to act as if you are in the US as that’s what I know (besides, math is universal) Also, I have to establish that you are looking to stay on this home forever, have no other debt to consider, you are at exactly 80% ltv, you are 35-40 (say 37.5 or 38) years old and plan to retire at 65. Last, I have to hypothetically improve your current situation to a fixed rate loan to simplify the analysis. Change any one of these variables and my answer may change.

What to do now? (Continuing with the above scenario)

Your current balance is now $193,303.35

Total remaining payments are $1,313.86 * 324 months = $425,690.64

Vs. the proposed new loan at a 1.5 % lower interest rate (adding the point plus a $23 courier fee for the docs because this most likely is not required out of pocket rather than from the loan proceeds)

Proposed new loan $195,260 @ 5.375 @ 360 = $1,093.40

New total remaining payments are $1,093.40 * 360 months = $393,624.00

So as it looks, at the moment, considering the life-of-the-loan total interest cost difference of $32,066.64 and the lower payment, you should take the deal.

But wait, if you stop here, you are missing some important factors like; rate of principle reduction, your equity position, loan term and to keep things brief I won’t even get into the effect on American tax advantages. These factors are more relative to your ongoing security, retirement planning and more.

So what’s your mortgage plan look like in 3 years? 10? 15? Retirement?

A, you take the new deal

Balance in… three years is $186,733.32, in 10 years $160,594.18 and in 15 years it is $134,910.12.
You will pay off your loan in 30 years in the year 2038 at the age of 68

Or B, if you stay with the loan you have:

Balance owed in… three years is $185,088.61, in 10 years $157,824.98 and inn 15 years it is $128,591.49.
You will pay off your loan in 27 years in the year 2035 at the age of 65

If you stay in your current loan you will always owe less/have more equity, you will owe longer, you will not have to make 3 years worth of payments during the first three years of retirement (almost $40k in payments you won’t have to worry about later in life)

To summarize the “catches” that you asked about;
1-a slower rate of principle reduction/equity recovery,
2-less tax advantages,
3-you owe on your mortgage longer (into retirement)

Continued with my clarification

Links:

• http://www.presidio-financial.com/wholesale/fraWelcome.asp?CompanyID=32542&...

posted February 26, 2008

Anant,
To be able to answer this question completely one would need to know the existing balance of your loan. The reason this becomes important is because of the capital markets structure. Today, loans over 417k with excellent credit and an ability to prove repayment can be capatilized through FNMA and Freddie MAC. While Non conventional financing carries more risk and significantly higher interest rates.
Should your loan be beyond the current 417k limit it would make sense to pay down the loan so that the refinance could be capitalized to FNMA or Freddie for the reduction in monthly savings. Recent law changes will raise this loan limit to 125% of the medium home price in your county for a short period in time this year, however pricing adjustment will be in affect. (Check with your bank to see where you fit)
Should the request be to pay prepayed finance charges equal to 1% (points, or discount) an arithmetic calculation should be able to solve the problem for you. Simply contrast the cost of the loan, vs. the savings in monthly installment. How many months will it take to match in dollars the actual cost of your loan? Should that number be less than that time you anticipate to live in the home, then it works if not, keep negotiating until it does.
Obviously, personal factors such as can you afford your current payment, or is your loan payment adjusting up after a reset should affect your decision as well.

posted February 26, 2008

Anant,

Please clarify - this 1.5% is your "fee" to them and it equals 1.55 of your loan balance but is not actually a payment toward your principal right?

it seems easy to me - currently, banks and brokers in my area are charging ~ $2,400 to close a mortgage. If 1.5% of your loan is much more than that, and you can get the same rate elsewhere, then go elsewhere. For example, your loan is 400k and your rate is 7.5%. Well, 1.5%x400k = $6,000 in fees and your rate goes to 6%. If you can get 65 and only pay $2,400 in closing costs then you have an answer.

Chris Grande
www.chrisgrande.com

posted February 26, 2008