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Should I Refinance My Mortgage?

Mortgage interest rates are at historically low rates.  Consequently, you may be wondering if it makes sense to refinance your mortgage.  Although there may be a variety of reasons for refinancing your mortgage, there are probably three primary reasons for you to refinance your mortgage.

  1. Lower your payments by borrowing money at a lower interest rate
  2. Convert your adjustable rate mortgage to a fixed rate
  3. Access some of the equity in your home (this isn’t as common or easy as it was a few years ago)

Since there are costs associated with refinancing a mortgage, the decision to refinance may not be a slam-dunk.  Essentially, you are paying money today, to save more money later.  As an example, assume that refinancing reduces your monthly payments by $50 per month.  If you have 25 years remaining on your mortgage, you will save $15,000 over the life to the loan.  If you assume you will pay $5,000 in closing costs to refinance, you save $10,000… over the next 25 years.

There are many different mortgage calculators available which will help you calculate your savings.  You can click here for one, or search the internet.  Keep in mind, internet calculators are only estimates, and the computations from your lender may be different.

Here are a few additional things to consider in your decision to refinance.

  • The time value of money – In my simple example above, you save $15,000 over the next 25 years, but you have to pay $5,000 up front.  Not only does it take you over 8 years to recoup your $5,000, you also lost the opportunity to invest that money and earn a rate of return (hopefully).  With interest rates on liquid assets near zero, the time value consideration may be nil.
  • Income taxes – The only refinance costs you can deduct are points paid to reduce the interest rate.  Unlike points you pay when you initially purchase your home, points paid on a refinanced mortgage must be amortized over the life of the loan (25 years in our example).  With a lower interest rate, your current mortgage interest deduction will also decrease, which could cause your current tax liability to increase slightly.  Although you’ll come out ahead by paying less interest over the life of the loan, your total benefit might be reduced by a smaller mortgage interest deduction.
  • Length of ownership – Since it’s likely to take you a couple of years of reduced payments to recoup the closing costs, you need to consider how long you plan to stay in your home.  If you expect to move in the next few years, the monthly savings may not be sufficient recoup your out-of-pocket costs for the refinance.
  • The loan process – The mortgage financing industry has changed dramatically.  It’s not easy for anyone to get a mortgage in today’s market.  I’ve had clients who experienced difficulties and delays in getting their refinancing approved, even though they could have easily written a check to pay off their existing mortgage.  The aggravation may be worth it, but expect the approval to be a hassle.
  • Market value – The fair market value of your home may be one of the biggest stumbling blocks to a refinance.  Market value is what prevented many people with subprime and adjustable rate mortgages from being able to refinance.  If you don’t have sufficient equity in your home, you won’t be able to refinance, even if you’re making your current payments, and the refinance will make it easier for you to continue making your payments.

Many advisors will tell you that the interest rate should at least 0.75-1.00% lower than your current rate for a refinance to be economically feasible, but depending upon your situation and long-term goals, a smaller rate differential might still be beneficial.

My advice is to run the calculation with an online calculator and see if it makes sense to you.  If the closing costs can be recouped within the next 5-7 years, and you don’t plan to sell before then, talk to a mortgage broker and get their advice.  A reputable broker will be able to give you a more accurate estimate of what it’s going to cost, the savings you can expect, and the process involved.

Refinancing your mortgage can save you money.  However, there are costs involved, and you want to make sure the benefits exceed the cost.

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The Mortgage Mess: It’s Still Messy

Even though the U.S. economy officially came out of recession in mid-2009, do you wonder why it doesn’t feel that way?  There may be a lot of reasons, but I think the continued turmoil of the residential real estate market is one of the key factors.

The housing market and mortgage industry may not be as messy as it was in 2008 and 2009, but it’s still messy.  TARP, HAMP and other government policies and programs may have stabilized the banking system and the financial markets, but the financial situation of many homeowners hasn’t improved much in the past five years… and for many, it’s gotten worse.

As this article cites, Zillow estimates approximately 16 million (one-third of all U.S. homeowners) owe more than their homes are worth (a.k.a. underwater).   It’s quite discouraging to think that after years of slugging through this challenging economy, you might be further behind today than you were five years ago.  Some areas of the country have definitely been hit much harder than others, but on a national basis, if you have positive equity in your house, one of your neighbors does not.  In Las Vegas, where I live, even though thousands of people have lost their homes to foreclosure and values have decreased by approximately 50% from the peak, a whopping seven out of ten homeowners are still underwater.

There are significant economic implications for having so many homes underwater.  It impacts people’s ability to relocate, puts them in a perilous financial position if their income decreases, limits their ability to refinance, and pares back their spending.  However, I think the most significant factor is the psychological effect it has on their outlook about the economy, the nation and their future.

For many people, their homes represent a significant portion of their wealth.  They may have spent years saving up for a downpayment or building the equity in their home, and it’s frustrating to see it wiped out in a matter of months.  Granted there were some people who bought homes they shouldn’t have, took out mortgages they couldn’t afford or treated their home like a personal piggy bank.  However, for millions of Americans, they simply bought at the wrong time and their homes lost value through no fault of their own.

The psychological effects of the mortgage mess should not be underestimated.  Owning a home is considered to be part of the American Dream.  It’s one of the reasons home ownership is much higher in the U.S. than in many other industrialized nations.  Sadly, the dream of millions of Americans turned into a nightmare.  Consequently, it’s only logical for people to feel apprehensive and fearful of the economy and the future, when something they thought was a sure thing (owning their home), turned out to be much more uncertain than they could have imagined.  Furthermore, home ownership is a very personal matter.  It’s unlike any other investment, because it’s the place where your family connects and memories are made.

Unlike the empty promises politicians often make, I won’t say there is an easy solution to the mess, nor do I think it’s likely to get cleaned up any time soon.  If there were an easy solution, it would have already been done by now.  Therefore, I think it’s going to be a long and arduous process to reduce the number of homeowners who are underwater.

Consequently, I don’t think we’ll see a resurgence in optimism about the economy, until the number of underwater homes is dramatically reduced.  It’s hard to feel positive about the future when you feel insecure or afraid of losing the place where you live and raise your family.

New Housing Starts: A Sign of the Times

 Real Estate has become a major component of wealth and the economic engine of the United States.  A robust construction and real estate sector fueled economic growth for over a decade. The true significance wasn’t understood until the housing market started to unravel in 2007.

Delinquent mortgages and foreclosures nearly collapsed the world financial system.  Plummeting real estate values, and the related property taxes, have created substantial fiscal challenges for state and municipal governments.   And… the dramatic reduction of new construction projects has rippled throughout the economy… in a harsh manner.

Consequently, the number of new housing starts is a closely monitored statistic.  The Conference Board’s composite index of ten economic statistics, includes housing starts.  Their number includes both permits and the actual start of construction for single-family housing units.

Real estate activity comprises nearly 10% of GDP.  The current real estate crisis therefore is contributing to the continued economic recession, and its slow recovery is one of the reasons that the economy is not likely to rebound anytime soon.

New home construction affects many areas of the economy.  The most direct impact is on building supplies and labor markets.  I recently heard one analyst state that the U.S. manufacturing jobs lost over the past two decades essentially transitioned to construction jobs.  This statement seems to be validated by the unemployment rates of the states hardest hit with distresses properties – Arizona, California, Florida and Nevada.  All except Arizona had unemployment rates well above the national average.

Consumer spending also accounts for 70% of GDP.  While it may not be easy to measure, new housing indirectly affects consumer spending.  Appliances and fixtures are often part of the new home cost.  However, there is a lot of indirect spending related to occupying a new home.  If you’ve ever moved into a new home, you know the amount of money you spend for new drapes, curtain rods, furniture and décor decking out your new digs.

In short, new housing construction is significant in the overall contribution and strength of the current U.S. economy. The glut of existing homes on the market, combined with a tight credit market and millions of Americans with poor credit, doesn’t create an environment conducive for new housing construction.  Therefore, do not expect to see any significant improvement in new housing starts anytime soon.  As such, the road to economic recovery will likely be longer and slower as a result of the lack of new housing starts.