With interest rates at all time lows, we are noticing an increase in refinance questions.  Please contact your advisor if you have questions or would like to explore how a refinance may or may not fit into your financial plan.

Why refinance your mortgage?

There are a variety of reasons why you may want to consider refinancing your mortgage, such as:

• Lowering your monthly mortgage payment by refinancing to a lower interest rate
• Shortening the length of your loan (e.g., from a 30-year mortgage to a 15-year mortgage) to potentially reduce interest charges over time
• Accessing extra cash through a cash-out refinancing to pay for home improvements, pay for college or consolidate debt.
• Refinancing your adjustable-rate mortgage (ARM) to a fixed-rate mortgage or a new ARM with better terms

When should you refinance?

Conventional wisdom said that you shouldn’t refinance unless interest rates were at least one percent lower than the interest rate on your current mortgage. However, even a .5 to .75 percent differential may be worthwhile to some homeowners. With today’s higher home values and commensurately higher mortgages, a slight reduction in rate over time may have a significant payoff. In addition to interest rates, you should also consider the length of time you plan to stay in your current home, the costs associated with getting a new loan, and the amount of equity you have in your home.  It may make sense to refinance if you’re confident that you’ll be able to recoup the cost of refinancing during the time you own the home. So, it’s essential to do the math ahead of time and calculate your break-even point (the point at which you’ll begin to save money after paying fees for closing costs). Ideally, you should be able to recover your refinancing costs within one year or less.

No cash-out versus cash-out refinancing

No cash-out refinancing occurs when the amount of your new loan doesn’t exceed your current mortgage debt (plus points and closing costs). With this type of refinancing, you may be able to borrow up to 95 percent of your home’s appraised value, depending on the type of loan requested and other factors. A cash-out refinancing occurs when you borrow more than you owe on your existing mortgage. In this case, you are often limited to borrowing no more than 75 to 80 percent of the appraised value of your property. Any excess proceeds remaining after you’ve paid off an existing mortgage can be used in any way you see fit.

Cash-out refinancing has certain advantages. The interest rate you’ll pay on the mortgage proceeds will usually be less than the interest rate on the other debts (e.g., car loans, personal loans, credit cards, and even some student loans). Moreover, the interest paid on your refinanced mortgage is generally tax-deductible when used for capital home improvements. There are also disadvantages to cash-out refinancing. With cash-out refinance, your refinanced mortgage is secured by a lien on your home. As a result, if you can’t make the mortgage payments, the lender can foreclose on your home and sell it to pay the mortgage.  You are also going to be paying the loan back for an extended period.  For example, paying off your car loan as part of your refinance could effectively put it on a 30-year repayment plan.  If you use a cash-out refinance loan, you can expect slightly higher loan costs or interest rates since the lender is taking on more risk.

The costs associated with refinancing

Be careful to understand the difference between no closing cost and no out of pocket closing costs.  Every loan has costs associated with it.  You can expect third party and lender related closing costs to range from $2,000-3,000. Your interest rate choices can incur additional fees, especially if your buying points to decrease the interest rate.  That’s why getting more than one quote is encouraged.  Often when lenders offer a no closing cost option, there are still costs involved.  They are just increasing your interest rate on your loan and covering the costs in the form of a lender credit.

While refinancing can often save you money over the life of your mortgage loan, this savings can come at a price. Typically, you’ll need to pay an assortment of up-front fees, including points and closing costs. Some lenders offer “no points, no closing costs” refinancing, which rolls the costs into your overall loan balance or charge a higher interest rate. Typical closing costs include:

• Application fee
• Appraisal fee
• Credit report fee
• Escrow Closing agent fee
• Loan origination/Discount fee
• Title insurance
• Reconveyance fee

Prepaid Items in advance – In addition to your closing costs listed above.

• Interest
• Property taxes
• Homeowners insurance.

If you have an escrow account on your existing mortgage, a refinance will close that account, and you will start a new one.  You’ll be sent a check 4-6 weeks after closing for the remaining balance in the old escrow account.

Are there any tax advantages with refinancing?

If you pay points when you refinance your mortgage, you may be able to deduct them. For points to be deductible, they must have been charged by your lender in return for a lower interest rate on your loan. If the lender points were charged for services provided by the lender in preparing or processing the loan, then the points are not deductible.  When deducting points, keep in mind that points paid on a refinanced loan usually cannot be deducted in the year you paid them. The points may need to be amortized over the life of the loan.

The one exception to the amortization rule is if you use part of your refinanced loan to make capital improvements to your primary residence. In that case, you may be able to deduct the portion of the points allocable to the home improvements in the year paid. Also, if you choose to refinance again or sell your home in the future, you can generally claim the entire unamortized deduction that remains.  For more information on the deductibility of points, you can refer to IRS Publication 936. As for other costs you may have incurred from refinancing, such as recording, title search, appraisal, and attorney’s fees, they are not deductible. Furthermore, unlike costs associated with a home purchase, costs associated with a refinance cannot be added into the cost basis (value) of your home for income tax purposes.

Disclosure

This information is educational in nature.  This article is not advice.  Please discuss your specific situation with your advisor, lender and tax professional before implementation.  Leonard Rickey Investment Advisors PLLC does not provide lending services.