An Insider's View of Refinancing (the 2009 remix ;~)

15 years ago

With the dropping interest rate environment of late, I've been fielding a lot of client questions (5 so far this morning) about closing costs, paying points (or not,) and comparing costs between various offers from brokers (who disclose everything) & retailers (who are allowed to hide/nondisclose some of their fees.)

From one of my emailed answers;

Regarding costs, keep these concepts in mind;

A) the services required are universal, and the costs don't really vary much,

B) because brokers fully disclose everything up front, the numbers ALWAYS look bigger compared to the retailers that do not disclose... but don't be hoodwinked! HUD studies showed most consumers wrongly chose retail offers thinking they were "cheaper" due to their lack of disclosure, to the consumer's financial detriment.

C)The rate-to-cost relationship is always inextricably tied together... And hidden (undisclosed) costs are simply paid for by a premium in the rate,

THE KEY STEPS TO REMEMBER;

1) FIRST focus on the STRUCTURE of your financing (including not just the costs of leverage, but the effects on the rest of your family portfolio from the unemployed portion of the unleveraged equity. Weight the tax effects of all options as well.)

2) THEN, knowing EXACTLY the structure that is in your best interests, look to 2 NUMBERS; the lockable rate (at the same lock period, same day considered,) and the gross cash to close.

A refresher;

http://www.fool.com/imo/2001/a011213.htm

(hotlink below)

NOTE:

When you suspect rates may soon (within 5 years) fall far enough to refinance AGAIN... Then you're often better off having some (or most) of your real costs rolled into a premium interets rate.

When you suspect rates are unlikely to realistically ever again go that much further to make a refinance (for the reason of capturing a rate drop) then your better financial choice is usually to have your closing costs paid from cash or equity.

Finally;

Choose your provider according to preliminary "quotes,"

And you've simply chosen the most successful Liar.

Choose according to character quality, competitiveness,

honesty, and your personal assessment,

And you will set yourself up for the better Experience AND

the better bottom line pricing!Â©

Cheers,

Dave Donhoff

Leverage Planner

Here is a link that might be useful: An Insider's View of Refinancing (the 2001 original)

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Comments (8)

sniffdog
15 years ago
Dan

My wife and I are in the process of refinancing to a 30 year fixed mortgage at 4.875% interest rate. When we do this - our monthly payment will actually increase beacuse we currently have a 10 year Intereste Only loan at 6.125 that we are 2.5 years into. When we built our dream home, we always planned on a refi - now seems the right time, maybe the best ever.

Now we are debating on whether we should prepay this 30 year fixed mortgage. We looked at bi-weekly payments as well as one extra payment at the end of the year (fullpayment all allocated to principal). We plan on living in the house for another 17 years, no more than 20.

We know the amount of interest we would save (total amount of reduced interest minus cost of extra payments).

Can you comment on when it makes sense to prepay vs when it makes sense to keep the cash and invest it? When we first looked at it - it seemed like a no brainer to prepay. But when we started looking at the other options (we are great savers), we thought we might do better keeping the cash and and investing it.

We enjoy reading your posts.

Thanks
dave_donhoff
Original Author
15 years ago
Hi Sniffdog,

Can you comment on when it makes sense to prepay vs when it makes sense to keep the cash and invest it? When we first looked at it - it seemed like a no brainer to prepay. But when we started looking at the other options (we are great savers), we thought we might do better keeping the cash and and investing it.

I'm VERY GLAD to read that you're double & triple thinking, with critical logic, about your financial management!!!

You need to determine what your real after-tax cost of interest is on your new mortgage. You can do that by determining your combined federal & state marginal tax bracket... then reduce your face mortgage interest rate by that factor.

Example;
Combined fed & state tax bracket = 35%
Face mortgage rate = 4.875%

Reduce the 4.875% by 35%... do this by multiplying 4.875% by the inverse of 35% (or 65%)...
So, 4.875% * 65% = 3.17%

SO... THIS is your net "cost of leverage" on the funds you seperate from your real estate.

NOW you can begin looking at your various options of those funds, and what the options are worth to you. I say it that way because there are more than only the obvious.

OBVIOUS is a straight comparison of savings & investment returns... i.e. can you get a post-tax return or interest credit better than 3.2?

ANOTHER very serious alternative benefit to consider is the REPLACEMENT VALUE of those funds for safety purposes.

Example; If you kept a chunk of funds in liquid access (checking account or money market account) at *only* a 2.2% yield... your difference between cost of leverage and credit would be a NET COST of 1%..... HOWEVER, doing so would give you the reserves that would allow you to AVOID the need to pay for a certain amount of insurance coverage. The savings on that insurance coverage offsets the net costs of your keeping the funds liquid... and often times puts you back in the net profitable range again (greater savings than costs.)

There are many more "replacement" considerations to think about as well, of course.... If you lock your money into the real estate equity to "save" 3.2%... and in doing so you fail to have enough cash to take advantage of a safe business or retirement investment opportunity that would have yielded 10%, you're losing big time... not just in returns, but in longevity risk (the risks of running out of income before you run out of breath.)

SO... weight carefully.

Luck,
Dave Donhoff
Leverage Planner
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Hi CK, This is so frustrating. Been working on this since mid-December. Got good faith estimates from 3 sources. ... and you are doing so because... (wait, don't tell me...) you are thinking that these GFEs are somehow actually meaningful, reliable, and valuable for something other than birdcage liner, right? Then rates went down a bit more (according to media) so got new estimates - rates down a bit, but closing costs up. Trying to time the financial markets by listening to journalists is complete and utter insanity. One went from no origination fee to now charging one. How do you know what you'll actually be charged at closing. Find an honest, competent financial professional you trust... and simply ask. What is a good faith estimate? A non-binding preliminary guesstimation of approximate rates and fees based on loose parameters known at the time is is prepared. Do the rates somehow tie to the origination fee? Sure... you probably missed my re-posting of recent. Check it out here; "" An Insider's View of Refinancing (the 2009 remix ;~) If they go down, are lenders forced to charge it to get the lower rate? Rates & Fees are linked, like a teeter-totter. I also don't like to be rushed, so when someone calls at 4:00pm & says you have until 4:01pm (an exaggeration but not by much) to lock the rate, my natural instinct is to back away. Good instinct... a BETTER instinct would be to shop your professional instead of the commodity... else you're begging to be had. I don't want my frustration to come back & bite me, and I know no one on here has a crystal ball - except maybe Dave Donhoff - Its still in the shop, unfortunately... but how can you find out what this is really going to cost you & what is a good rate today? All you hear is that rates are going down - but not so today? The answer is my ancient, shop-worn rant; Choose your provider according to preliminary "quotes," And you've simply chosen the most successful Liar. Choose according to character quality, competitiveness, honesty, and your personal assessment, And you will set yourself up for the better Experience AND the better bottom line pricing!Â© Cheers, Dave Donhoff Leverage Planner Here is a link that might be useful: An Insider's View of Refinancing (the 2009 remix ;~)
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sniffdog
15 years ago
Dan,

Thanks very much for the detailed response. I will go over it with my wife.

Given the mortgage rate we are getting and the tax bracket we are in, not prepaying is most likely the best choice for us.
blueheron
15 years ago
Dave, I see you get Don and Dan, LOL!

I wanted to know, what is leverage, exactly?
dave_donhoff
Original Author
15 years ago
Hi BlueHeron,

Of course, you could Goog it for the various dictionary definitions... but in the financial context Leverage is the unique useage of Debt to acquire and control Growth or Protective Assets.

In very short; It is "good debt." The stuff that safely gives you legitimately more benefits than its costs.

Cheers,
Dave Donhoff
Leverage Planner
sniffdog
15 years ago
Dave

Sorry for the corn fusion. My DW let me have it "You called him Dan twice!". The info was much appreciated.

We had come to this conclusion after running mortgage calculators. In fact, we did the analysis twice about a month apart, but forgot that we had done it the first time! I guess the good news is that we came to the same conclusion both times.

We also got incorrect info from our lender. While I was talking to her about prepayment, she said that if we made one extra full payment (PITI) per year and applied that to the principal that our mortgage would be paid off in 17 years. This was during a conversation about bi-weekly payments since our bank actually charges a fee to do that. The lender told me we could accomlish the same thing with either a) one extra payment per year, or b) divide the total of 1 extra payment by 12 and apply that extra against principal each month. Both of these approaches could be done for no fee, and do in fact accomplish the same thing as a bi-weekly (every 10 businness day) payment approach.

After I got off the phone, DW and I were discussing this and thought about the payoff in 17 years comment and thought that too good to be true. Turns out it was - the payoff is actually 25 years. And we confirmed that with both my spreadsheet and a Kiplinger mortgage calculator that is online.

So once we figured all this out, we started thinking that that one full payment was actually quite a bit of money. It seemed like the "slam dunk" really wasn't a slam dunk after all. I think if the interest rates were much higher, then a prepayment might make sense. But not when we are getting such a low interest rate.

It was nice to get confirmation from a pro.

Thanks again - Dave!
dave_donhoff
Original Author
15 years ago
Sniffer,

No worries on the name thing... I've had it my entire life, given the nature of alliteration's effect on people's short-term memory. My Dad had it worse... his name is Ron, so he's perpetually called Don.

In any case... glad you guys are seeing the better path, *AND* I want to re-emphasize a key point;

ELIMINATING a mortgage is BEST NOT attempted bite-by-bite (the way you would successfully eliminate credit card debt, for example.)

INSTEAD, to eliminate your mortgage SAFELY, you're best advised to aggressively fund a safe SIDE-ACCUMULATION account (many people call it their "Mortgage Freedom Account.")

Your mortgage costs simple, non-compounding interest.
Your MFA earns COMPOUNDING interest.

This alone means that your MFA could (in worst case) earn a lower face interest rate, and STILL catch up and beat the costs of your mortgage interest in time.

Combine your MFA compounding interest in a tax-deferred, or tax-FREE strategy, and you not only keep your safety funds in place by keeping your nest-egg from getting trapped in your real estate, you ALSO blow the doors off the interest costs of the mortgage by superior MFA growth.

Here's to a successful 2009!
Dave Donhoff
Leverage Planner
sniffdog
15 years ago
Dave

Agree on the separate fund. We have had a "House Fund" with Merrill Lynch for many years. Originally the purpose of the fund was to stash money we saved with a lower interest rate on an Interest Only Loan. That was back in the day when 30 year fixed mortgages were 1 to 2 points more than IOand when these types of mortgages were not widely available. Our financial planner set this up for us.

We have continued to stash into this fund and will do so even with the 30 yr fixed based on the info we got here. When we get ready to retire we can refi and buy down the mortgage or have no mortgage.

Thanks for the insights.

An Insider's View of Refinancing (the 2009 remix ;~)

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An Insider's View of Refinancing (the 2009 remix ;~)

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