The current low-interest rate market has
created extraordinarily attractive opportunities for refinancing. Some
borrowers, however, will make better use of the opportunity than others.
This article sets out what a borrower needs to know to make the right
decisions on whether to refinance, how to refinance,
where to refinance, and how to remedy a poor choice by
rescinding a refinance.
Refinancing Criteria
The obvious criteria is the interest rate the applicant can
find in the market relative to the rate on her existing mortgage. This
is complicated, however, by refinancing costs which are out-of-pocket
unless the applicant has the lender pay them, in which case the new
interest rate will be higher than it would have been otherwise. Such
lender payments are termed “premiums”.
Premiums are the opposite of “points”, which are payments made by the
borrower on top of other refinance costs, in exchange for a lower
interest rate.
The best way to select from different price quotes involving both
rates and points is to compare total costs over a future period that is
applicants’ best guess of how long they will have the new mortgage. This
is the method used by my
calculator 3a.
A second-best approach that does not require a calculator is
to shop for the lowest interest rate at specified points or premiums.
Employing this approach, here are some useful rules of thumb:
- If the applicant expects to sell her house within 4 years, she
wants a “no-cost” loan, meaning one that carries a premium large
enough to pay all the refinance costs. The alternative of paying
cash to cover refinance costs might appeal to a borrower who wants
to minimize the monthly mortgage payment.
- If the applicant expects to be in her house 6 years or longer,
liquidating low-yield assets in order to pay rate-reducing points is
a prudent investment.
Refinancing Two Mortgages
An applicant with two mortgages needs to compare the total cost of
retaining the two existing mortgages over her time horizon with the cost
of refinancing into one or two new mortgages over the same period. While
there are no simple rules of thumb for doing that, my
calculator 3b does it and is simple enough.
Refinancing With Cash-Out
Borrowers who want to extract cash from their refinance should expect
to pay a higher price. The reason is that borrowers who extract cash
have poorer payment records than borrowers who don’t.
An annoying complication, however, is that the definition of cash-out
is broader than the extraction of cash. Any refinance that occurs within
12 months of a previous cash-out refinance, or within 12 months of a
second mortgage that was not part of the home purchase, is also
considered cash-out and priced accordingly. If either of these
contingencies apply, the borrower might want to wait until the 12-month
period has elapsed.
Financing Closing Costs
Borrowers who are short of cash can include the closing costs in the
loan balance without the transaction becoming “cash out”. In fact, the
rule allows the borrow to finance the costs plus the lower of $2,000 and
2% of the loan amount.
Refinancing With Cash-In
Cash-in refinancing is the opposite of cash-out refinancing in that
the borrower pays down the balance as part of the transaction. The
purpose is to reduce the mortgage price and/or the mortgage insurance
premium by increasing the borrower’s equity in the house.
Borrowers with an existing loan balance that exceeds 80% of equity
might find this an attractive investment in a market in which
alternative investments carry very low yields. The rate of return on a
cash-in refinance that is comparable to the rate on investments, can be
obtained from my
calculator 3f.
Refinancing With Current Lender
The case for refinancing with your existing lender is that, under
some circumstances, that lender can refinance you with minimal
settlement costs. The lender may forgo a credit report, property
appraisal, title search and other risk control procedures that are
otherwise mandatory on new loans.
Indeed, if you are looking only to reduce the interest rate, and not
to take any cash out of the transaction, and if your payment record has
been good, your existing lender may elect simply to reduce the interest
rate on your current loan rather than refinance it. This replaces all
settlement costs with a small fee for amending the contract.
Unfortunately, however, the separation of loan origination and loan
servicing functions has largely eliminated these options. Firms
servicing loans owned by others (including Fannie Mae and Freddy Mac)
must follow the rules stipulated by the owners, and these rules never
allow the servicer to adjust the rate on an existing loan. The only
lenders with this flexibility are the few who service the loans that
they own.
There is one other deterrent to borrowing from the existing lender.
The rule granting applicants an option to rescind does not apply to
transactions with the borrower’s existing lender.
Bottom line, borrowers are best served by shopping the market, taking
advantage of internet-based sites on which lenders compete.
Avoiding Discrimination
I have never met a mortgage loan officer or broker who would
relinquish the commission on a loan in order to reject an applicant of
the wrong color. Applicants who question that can protect themselves by
shopping at internet sites on which they can qualify themselves and
price their mortgage without disclosing their race.
It would be extremely difficult for a lender receiving a lead from an
internet site to reject the deal after the applicant has entered the
application phase and discloses her race. The lender would be required
to document the reasons for a rejection. If instead, the lender changes
the price so that it no longer conforms to the price on the site,
a refinancing applicant can rescind the deal, converting it into a loser
for the lender.
Right of Rescission
Under the Federal Truth in Lending Act, borrowers who refinance a
loan on their primary residence with a lender other than their current
lender, can cancel the deal at no cost to themselves within 3 days of
closing. This "right of rescission" can be valuable protection for
borrowers who realize they have made a mistake, or suspect that the
lender has abused them in some way.
Here are some details that will be useful to anyone considering a
rescission:
- To exercise your right, send a letter of rescission registered
mail with return of receipt requested. This will avoid the
possibility that the lender places your letter in the shredder and
claims it was never received.
- Within 20 calendar days of receipt of your letter, the lender is
obliged to return any payments you have made to anyone in connection
with the transaction.
- If your closing documents do not include a written
statement of your right to rescind, you get three years to rescind
instead of 3 days.
For a variety of reasons, most borrowers who decide their refinance
was a mistake don’t realize it for weeks or months after the closing.
For the borrower three days is not enough, but an extension would impose
major costs on lenders, as well as on borrowers who have no need for an
extension. The moral is that borrowers who feel uneasy about their
refinance should check it out with an expert within the 3-day period.
