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6 things to ask before you Refi

December 2002
6 things to ask before you Refi

With the low cost and competitive market of borrowing, homeowners nationwide have been rushing to refinance, a process that allows them to trade in theirs old loans for a new one with lower monthly payments.

But before you race to join them, make sure you know what to ask so you pick the deal that?s best for you. Here are six questions you should have answered before you sign on any mortgage application.

What?s my break-even point?

First and foremost, the decision to refinance depends on whether it?s worth for you from a financial standpoint. To determine that, you?ll need to know how long it will take for your monthly savings to offset your closing costs. In other words, when will you break even?

In general, the bigger the loan, the faster the payoff. To determine your break-even point quickly, divide your monthly savings into your expenses to determine how long it?d take to recoup your costs. If you save $150 a month with a new loan and you pay $2,400 in expenses, it would take 16 months to break even. That means you need to stay at least 16 month in that house to break-even.

The lower the break-even point, the better. But always remember, you shouldn?t wait more than three years to break even because there?s a strong likelihood that you could move to new house or swap mortgages again.

Should I choose a fixed-rate mortgage or an ARM?

When you refinance your loan, you?ll have to select from an ever growing number of financing options.

You?ve got 15-year and 30-year fixed-rate mortgages, in which your rate never changes. And then you?ve got the adjustable rate mortgage (or ARMs), which offer lower introductory or ?teaser? rates for the first 1-, 5- or 7- years. After that period, however, ARM rates will change (usually up) along with the economy and based on prime rate.

It is difficult to recommend any loan because it does depends on you and your financial conditions. You will have many options. But only one is right for you. Knowing which depends on a slew of factors, including how much longer you have to pay off your loan, how long you plan to stay in your home and your goals for refinancing in the first place.

Are you hoping to cut your monthly payments or the amount of interest you will pay over the life of your loan? If you only are concerned about the monthly payment, then getting into the 30-year fixed rate loan, with the lower interest rate, will be good one. But if you?re able to afford to pay more each month and more oriented to paying down principal and getting quick equity, your options become more complicated.

For example, moving to a 15-year fixed loan from a 30-year will cost you more out-of-pocket per month, even with lower rates. But you?ll pay off your mortgage sooner and save thousands in interest fees overall. Another option? Switch to an ARM that?s fixed for the first five years to secure even lower rates and plow savings into extra principal payments. This could let you pay off your principal even faster.

The rule of thumb: If you?re thinking about leaving your home in five years or less you should snag the lowest rates possible with an ARM. For those staying put, however, the fixed-rate varieties are a better bet, offering the assurance that you?ll never pay more in the future.

What?s the best way to compare refi options?

If you?re choosing between several fixed rate mortgages, pay close attention to the APR. That?s short for ?annual percentage rate? and it includes not only the interest rate you?ll pay but any fees, mortgage insurance and points. (A point is equal to 1 percent of your loan amount).

It is difficult to compare when you are taking ARM loan. That?s because when lenders give you an APR for an adjustable rate, they?re using best-guess estimates of what your underlying interest rate will be in the future and those estimates can be way off the mark.

Is no-cost refinancing good for me?

When it comes to refinancing, it doesn?t take long before homeowners are flooded with an array of fees, including title insurance and searches, appraisals, credit reports, underwriting fee, overnight mail, attorney costs, escrow accounts and bank fees excluding points that you may pay to lower your interest rates. These costs can be 1.5%-2% for the $200,000 loan and 3%-3.5% for the $100,000 loan.

But these days, as the mortgage market stays competitive, some lenders are offering no-cost refis. You don?t have to pay points or fees for the loan. A great deal, right?

No-cost loans may pick up the fees, but your lender is going to charge you higher interest rates ? typically about 0.5 percent more ? than you?d otherwise pay if you shouldered those costs yourself. Again, it depends on your loan amount. Eventually, the higher rates surpass what you would have paid in expenses. For that reason, no-cost refi?s tend to be better for folks who don?t plan on staying put for long.

If you?re planning to move next year, it?s hard to get enough savings out of a lower rate, but it depends on how much money is involved. The bigger the loan balance the faster the savings add up.

What?s the lock-in period?

These low rates are enticing but it is taking a long time to close a loan- about 30-45 days. For that reason, it?s imperative to know how long that low rate is good for you.

Unfortunately, too many individuals don?t ask this to the broker. That can spell disaster because individuals may sign up for a refi and end up paying higher rates than they thought by the time they close. 45 days locking usually takes .25% of loan amount against 30 days loan.

Is there any prepayment penalty?

In many cases, lenders ask for prepayment penalty if you pay earlier than your given time. If your credit score is poor and not financially stable, they also claim for higher interest rate. When you are refinancing, examine is there any prepayment penalty? If so look for other brokers who can direct your loan to other lenders who will not ask for prepayment penalty.

If you don?t any other options, pay until prepayment time, and build-up your credit, and re-fi again.

Moneywise is hosted by Rajesh Jyotishi with Shalin Financial Services, Inc.

An Investment Advisor Representative of FSC Securities corporation. A Registered Broker Dealer. Member of NASD/SIPC. For questions he can be reached at 770-451-1932, ext. 101

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