Note to Readers: This post is the second in an occasional series on personal finance topics that may be useful for a broader audience than The Rational Walk’s typical focus on value investing. Please feel free to pass along a link to this article to clients or associates who may benefit from the material.
The past few years have been a very stressful time to be a homeowner, particularly for those who purchased their homes near the height of the real estate bubble and now owe more on their mortgages than the property is worth. A record 2.8 million homeowners received a foreclosure notice in 2009 and the number is expected to rise even further in 2010. The decline in housing prices combined with unemployment rates that have not been seen since the early 1980s have caused the current debacle.
Recession’s Silver Lining: Low Mortgage Rates
Although the recession has created a great deal of economic pain, there is a silver lining: Interest rates remain at very low levels. Those who are still employed, have reasonable credit scores, and own homes that are worth more than their mortgages can take advantage of mortgage rates that remain under 5%. This opportunity is particularly compelling for those who purchased homes earlier in the last decade when interest rates were often higher than 7%. When the economy improves, many economists expect interest rates to increase substantially so the window of opportunity for refinancing may not last for long.
Calculate Payback Timeframe
Many homeowners think about refinancing from time to time but are discouraged by the fees involved in the process. It is usually necessary to pay mortgage origination fees and sometimes lenders will charge financing fees (or “points”) if a borrower is seeking the lowest possible interest rate. In addition, the home must be appraised to ensure that sufficient equity remains in the property to protect the lender.
While paying a few thousand dollars may seem like a steep expense to incur up front, many borrowers can recover this cost very quickly since the portion of their monthly payment attributed to interest will decline due to the lower interest rate on the new mortgage. There are many mortgage calculators available to help borrowers determine whether the terms of a proposed refinancing transaction make economic sense. Much depends on how long the homeowner intends to stay in the home since selling too quickly may result in the upfront refinancing costs not being fully recovered.
Consider a 15 Year Loan
Many borrowers should consider switching to a fifteen year loan when refinancing. While it is certainly true that fifteen year loans carry a higher monthly payment, the interest saved over the life of the loan can be very substantial. A fifteen year loan may be very attractive to individuals who purchased their home more than seven or eight years ago. While the payment will be higher than the thirty year term, the increase in payment will be offset by the fact that the principal amount of the new loan will be lower than the original loan and, of course, the new interest rate will be lower than the old rate.
Refinancing is not the best solution for everyone and, unfortunately, many homeowners today simply cannot qualify for a new loan due to impaired credit, unemployment, or severe declines in the price of their homes. For those who do qualify and intend to remain in their homes for the long haul, refinancing might be a wise financial move to make in 2010.