Deciding When To Refinance Your Mortgage

December 21, 2008

I was recently propositioned by my original lender. He offered me a new 30-year fixed mortgage at 5.25%, which is a full 1% lower than my current 6.25%. This would save me roughly $200 on my monthly payment. Sounds great right? The catch is that I would have to pay closing costs to the tune of $1,600. Also, I would be starting over again on a new 30-year fixed mortgage.

Factors Affecting Refinancing Your Mortgage

  • Interest Rate – Obviously, the major driving force in refinancing a mortgage is the interest rate. Everything else equal, the lower the interest rate, the lower the monthly payment. The sudden increase in mortgage refinancing inquiries is due to the dropping interest rates. The current national average for interest rates on a 30-year fixed mortgage is 5.27% via bankrate. There’s a common misconception that you only refinance your mortgage if you’re lowering your interest rate by 1-2%. Really, what it comes down to is how long until you reach your break even point.
  • Closing Costs – Closing costs are the major drawback when considering whether or not to refinance your mortgage. Closing costs can be as high as 2-3% of your loan amount and they can be completely waived. Also, you can use negative points, which involves a higher interest rate, to cancel out your closing costs.
  • Break Even Point – Your monthly payment and closing costs effectively determine your break even point. To determine your break even point you take your monthly payment savings and divide it into your closing costs. This will tell you how many months worth of payments will transpire before you recoup your closing costs. After determining how long it will take to reach your break even point, all you have to do is think about how long you plan on keeping your mortgage and evaluate based on your current financial needs.
  • Remaining Length of Mortgage – When you refinance your mortgage you are agreeing to take on a brand new mortgage. You are not keeping your old mortgage with a new rate. If you have already made 5 years or 15 years of payments do you really want to agree to 30 more years? That may not sound like a good idea, but you can take your monthly savings with the lower rate and add it in as an extra principal payment. Also, you can always try to refinance your loan into a shorter term loan.
  • Type of Current Mortgage – The type of mortgage can be a defining factor when deciding to refinance. You might have enough equity in your property to refinance into a 15-year fixed rate mortgage and save some money on interest payments. You might have an Adjustable Rate Mortgage (ARM) where you want to refinance into a fixed rate mortgage. If this is the case, you might even take a higher interest rate than your current ARM rate because the interest rates will raise in the future.
  • Prepayment Penalties – I don’t know how frequent prepayment penalties are a factor for mortgages. I don’t have a prepayment penalty associated with my mortgage. These penalties are used by lenders to make sure they don’t lose out on the interest they feel they are entitled to since every extra payment on principal results in less interest earned by the bank. If you do have a prepayment penalty just add that to your closing costs when determining your break even point.

Conclusion

I decided not to take the refinancing deal from my original lender that I described above, because I did not like my first experience with him and I feel like I can get a lower rate. Although, my break even point with that deal was only 8 months, which is good considering I plan on staying in my condo for at least 5 years.

I don’t have a prepayment penalty and I don’t have to worry about my current mortgage as I’ve only made one payment. My original lender sold my mortgage to Wells Fargo, who I have been very happy with so far. I will most likely look into refinancing through them to give them a chance to keep my business. If I don’t find an acceptable break even point I will start looking around at other banks.

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My First Mortgage Payment And Updated Amortization Schedule

December 19, 2008

I made my first mortgage payment on December 15th, which is 2 months and 12 days after closing on my condo. I used the two and a half months with no payments to build up my cash reserves, pay for furniture purchases and start saving for retirement. Now that I have started making mortgage payments, I’ve decided to update my amortization schedule (see below) with the official loan value, interest rate and monthly payment. I originally posted an estimated amortization schedule, along with information to create your own amortization schedule.

amortization-schedule2

An amortization schedule is very important to create and interpret, especially when deciding whether or not to refinance. With the dropping interest rates, I may be afforded the opportunity to refinance at an interest rate below 5%, which would decrease my monthly payments by over $200 and allow me to make extra principal payments.

Amortization schedules allow you to see how much interest you will be paying over the life of your loan. They allow you to see how much extra principal payments decrease the length of your loan, as well as the amount of interest you pay.

As you can see from above, my first month’s payment was $1,392.75. $1,178.13 went towards interest, while only $214.63 went towards my principal. The paltry amount that went towards my principal makes me want to make additional payments towards principal to help build more equity in my condo. I now have to weigh whether or not I want to pay a little extra towards principal or save for my retirement. At least initially, I think the retirement savings will win.

In the near future, I will be playing around with my amortization schedule in excel to see how much extra principal payments may benefit me. Also, I will be looking at how decreased interest rates will enable me to save more for retirement and pay more towards my principal.

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Dropping Mortgage Rates And My Current Thoughts On Refinancing

December 18, 2008

My mortgage lender called me today to offer me a 5.25% interest rate if I refinanced my mortgage. This would lower my interest rate by 1%, which amounts to $200 a month in savings. The catch is that I would have to pay closing costs again, which are $1,600. In a strictly financial sense, I would break even after 8 months. In the end, I think I’m going to hold out for a lower rate or a lender that will waive or reduce the closing costs.

Dropping Mortgage Rates

Back on November 26th the Fed said that it would purchase $500 billion dollars of mortgage backed securities from Fannie Mae and Freddie Mac. Also, the Fed said they would buy $100 billion in direct debt issued by Fannie and Freddie. After this announcement, mortgage rates dropped from about 6.0% to 5.5% in a week. Mortgage applications more than doubled after the drop in the interest rate. Follow this LINK for more information.

Are the Mortgage Rates Dropping Further?

The Federal Reserve unveiled a proposal in late November or early December for the Treasury to buy securities backed by 30-year fixed-rate mortgages from Fannie Mae and Freddie Mac. This act would cause mortgage rates to drop. The treasury wants to bring mortgage rates down to around 4.5% as a way to reinvigorate the housing market. Bankrate has a good article by Dr. Don Taylor about the interest rate potentially dropping to 4.5%.

Why Didn’t I Refinance?

I am by no means an expert on mortgages and/or refinancing, but I am hoping the mortgage rates will move closer to the 4.5% level. Also, I don’t believe the full closing cost should be required to refinance my mortgage. This is the same company that gave me my original mortgage (it has since been sold to Wells Fargo) and my coworkers and parents have never paid closing costs on a mortgage refinancing.

Originally, I was happy with my mortgage lender. He was super helpful explaining everything to me and walking me through my first mortgage experience. Then came the month prior to closing. My lender did not frequently return my emails and phone calls regarding locking in my mortgage rate. His estimated closing costs were not very close and he seemed just disinterested in to talk with me.

Imagine my surprise when my lender calls ME and offers to refinance my mortgage. This tells me that they are really in need of some money. Here’s a paraphrase of his sales pitch (and it was exactly that):

I’m in a position to drop your mortgage rate a full percentage point to 5.25%. This is a savings of $200 a month. The catch is that you have to pay closing costs again, which are just under $1,600. I wish I could lower the closing costs, but with the current economy we have to reappraise the value of your property again. By the way, this offer needs to be agreed on 5 minutes ago.

I take this as a desperate sales pitch for a mortgage lender that really needs some extra cash. First of all, why does my property need to be reappraised? It was appraised just over two months ago and it was new construction. How could it have decreased significantly? You can’t tell me this appraisal will cost $1,600, so why can’t he waive the rest of the closing costs? Other mortgage lenders have been able to do so before.

Bottom Line

I am not comfortable dealing with a lender who is unwilling to provide me with ample time to do my research and consult with my friends and family. Instead of making me feel comfortable with a major decision, it seems like he’s trying to bully me into making a rushed and rash decision. I don’t know if the mortgage rates will drop any further, but I am fairly confident that they won’t be increasing in the near future. At the very least, it’s a very good feeling to know that I will be able to lower my interest rate and monthly payment.

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How Obama Might Affect Your Taxes And Personal Finances

November 6, 2008

Barack Obama was voted the new president elect yesterday. Very early in the campaign, the number one issue changed from the war in Iraq to the slumping economy. Obama has preached change throughout his campaign and the most pressing issue that requires change is the economy. Additionally, Democrats hold the majority in both houses of Congress and in combination with Obama will quickly try to turn the economy around in ways that may affect your mortgage, taxes and retirement plans.

Retirement Plans

Obama has entertained the idea of temporarily eliminating the annual required minimum distributions from IRAs if you are 70 or older. The idea is that you shouldn’t be forced to sell losing investments if you don’t need the income. Obama has also mentioned making the required withdrawals tax free for a short time.

He has proposed temporarily removing early withdrawal penalties on $10,000 of savings from 401ks and IRAs. The money would still be subject to federal and state income taxes.

A more permanent proposal may include matching 50% on the dollar for the first $1,000 of retirement contributions if your income is less than $75,000. I am all for any proposal that encourages retirement savings. He has also proposed requiring employers to set up automatic contributions to IRAs (if a 401k or similar retirement plan is not offered) for employees. The employees would then have the option to opt out. I have read that more employees participate in retirement savings programs if they are automatically enrolled and have to opt out.

2nd Stimulus

Prior to the major bailout plan, Obama proposed a 2nd stimulus plan, which would result in roughly $500 stimulus checks for individuals and $1,000 for families. The stimulus plan would also encompass help for small businesses and failing mortgages.

Tax Plan

Obama has proposed reinstating the 36% and 39.6% tax rates for individuals with income of $200,000 and joint filers with income of $250,000. He plans on keeping all other income tax rates the same as the Bush levels. Obama plans a similar tax increase for capital gains rates. He plans on increasing the top capital gains tax rate to 20%.

Obama’s plan does include tax cuts in a few areas for lower level income filers. He wants to eliminate income taxes for low income seniors. He wants to add or increase tax credits for Social Security taxes, college expenses and mortgages who don’t itemize. Obama has also mentioned offering a refund from taxes levied on oil companies, although with the gas prices on the decline, I don’t know how much steam this refund will gain.

Mortgages and Foreclosures

Obama has proposed including a 90-day moratorium on foreclosures for firms receiving help from the $700 bailout plan. This plan includes the ability to buy troubled mortgages and restructure them. Obama also favors providing bankruptcy judges the power to write down mortgage debt. There is an argument that allowing judges to modify loans could lead to higher mortgage rates for future home buyers.

Conclusion

The next year will be extremely interesting. While doing research on Obama’s website, I browsed through all of his ideas for creating jobs, improving infrastructure, furthering energy independence, etc. and I just don’t see how he can not raise taxes. All of these ideas for change and tax cuts sound wonderful. I’m all for energy independence and promoting research and science jobs, but I just don’t see it happening without increasing taxes. Even though I don’t know how Obama will make it happen, I suppose I’m willing to see what he can do. Anybody else have thoughts as to how Obama’s tax plans and economy rescue plans will affect main street?

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The Anatomy of My Credit Score

October 12, 2008

Two weeks ago Equifax was offering a free credit score for the first 10,000 applicants. Fortunately for me I was able to take advantage of this offer. It was very interesting to see my credit score as I was closing on my condo that same week. Equifax calculated my credit score to be 723 and put me into the “Good” score.

Equifax Scores and Classifications

Equifax scores range from 300 to 850. My score of 723 puts me above 50% of US consumers. Equifax has five categories to classify your credit: bad, not good, good, very good and great. Bad ranges from 300-559, not good ranges from 560-659, good ranges from 660-724, very good ranges from 725-759 and great ranges from 760-850. Looks like I just missed having a very good credit score by two points.

Factors Affecting my Score

There are four categories that Equifax looks at when determining a credit score. These four categories are amount of debt, amount of new credit, payment history and length of credit history. I was rated as good in the amount of debt category, very good in the amount of new credit category, great in the payment history category and not good in the length of credit history.

Factors Hurting my Score

The following factors are hurting my score with the first factor having the greatest negative impact.

  • Short Credit History – This factor measures both the age of the longest account and the average age of all accounts. The age of my longest account is 5 years and 11 months. The average age for the longest account of high credit scores is 19 years. The average age of my accounts is 3 years. The average age for high credit scores is between 6 and 12 years. The negative impact of my short credit history will only diminish if I continue to make payments on time.
  • Recently Been Looking for Credit – This factor measures how many hard credit pulls were performed on your behave over the past 12 months. Apparently, people who are actively seeking credit are riskier to lenders. I had 2 credit inquiries over the past 12 months. 72% of high credit scores did not have any credit inquiries in the past 12 months.
  • No Recent Activity on Revolving Accounts – This factor looks at the activity on revolving credit accounts such as credit cards. People who demonstrate the responsible use of revolving credit are less risky. I don’t really understand this ding on my credit score as I have two open credit cards that I use regularly. I have one closed credit card. I also have a car loan, which I have paid on time for over two years. Either something is wrong on my report or I don’t fully understand the definition of recent activity on revolving accounts.

Factors Helping my Score

The following factors are helping my score with the first factor having the greatest positive impact..

  • No Missed Payments on Credit Accounts – This factor is pretty self-explanatory. If you make your payments on time you are less risky. I have 0 missed payments on my account. 93% of high scorers have no missed payments at all. Those who do have missed payments missed the last payment nearly 4 years ago on average.
  • Low Balance on Revolving Accounts – This factor evaluates how much of your available credit you use. I have $226 on my revolving accounts, which is interesting because I just recently purchased a new lcd tv and it was definitely more than $226. The average balance for high scorers is $2,300, which seems like a lot.
  • Moderate Number of Credit Cards – This factor looks at the total number of open and closed credit cards. I have 3 total accounts on my credit history. The average number of accounts for high scorers is 4 to 5. I disagree that the total number of credit cards should be a factor in determining credit score. Does it really matter how many cards you have as long as you keep the total balance low and pay it off every month? Also, why does it matter how many closed accounts you have?

How Lenders View my Credit Score

According to Equifax, my credit score of 723 leaves me with a risk rate of 5%. The higher the credit score, the lower the risk rate. The risk rate is also defined as a delinquency rate. Equifax defines the delinquency rate is defined as the percentage of borrowers who reach 90 days past due or worse on any credit account over a two year period. The following chart shows how the delinquency rate varies with credit score.

Conclusion

I was very lucky to stumble on a free copy of my credit score. Overall, I am very happy with Equifax’s presentation and explanation of my credit score. I don’t necessarily agree that the activity of my revolving credit accounts has been low and if I hadn’t already received my loan I might question the accuracy of that factor. Also, I completely disagree that closed credit card accounts factor into a credit score. Similarly, if closed credit card accounts factor into a credit score, why don’t paid off loans? I have completely paid off a hefty school loan and it is not reflected in my credit score. In the end, I would recommend getting a copy of your credit score if you are taking out a loan for a large purchase in order to maximize your score.

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My Mortgage Closing and Effects of the Credit Crisis

October 7, 2008

After a long and tiring weekend of closing, moving and unpacking I finally have my wireless internet set up and I’m ready to get back to my personal finance blogging. I imagine most of my posts will be looking forward towards my financial future as a home owner, but first I want to post about the closing process and how the credit crisis effected my housing loan.

Interest Rate

Previously I wrote about the effect of the government takeover of Fannie Mae and Freddie Mac on mortgage interest rates. My lender told me at that point that I had the option of locking in my interest rate at 6.0%. I declined to lock in the rate, as I thought the interest rates might drop lower. It was at this point that my lender at BancGroup went MIA. I constantly inquired about the current interest rate in order to make an informed decision about locking in my interest rate. I did not hear back from my lender about the interest rate until the day before I was supposed to close, when I was informed my rate would be 6.25%. Due to the lack or communication I was extremely unhappy with my lender, but it was too late to do anything about it.

Credit Crisis

Back in December when I first started looking at condos, I got pre-approved by BancGroup for a loan of $300,000. All I needed to do to get pre-approved was provide current assets for a down payment, my most recent pay stub and my planned down payment percentage, all of which was done over the phone.

As my closing date neared, the credit crisis started taking effect. About a month before my closing date, I faxed copies of my most recent pay stub and my most recent bank account statements. I even went so far as to provide the last statement from my CD to prove that the giant deposit on my most recent bank statement was in fact my money. I was told this was all that was necessary to ensure a loan.

Three days before my closing I was informed that my college diploma was needed, so I faxed over my diploma. Two days before my closing I was informed that I needed to provide proof that the earnest money checks came from my bank account. Also, I had to fax over a second bank account statement for each bank account. Additionally, I had to prove that I in fact closed my CD, despite the fact that I already sent over a statement that matched up very closely with the deposit into my checking account.

It was very aggravating to have to continually prove that I was worthy of a loan for the amount of about $220,000 when I was already approved for a $300,000 loan. It really shows how lax the lending criteria was in early 2008 and how strict it has become over the past few months. I can understand the extra scrutiny, however, I don’t understand why it had to be done last minute. It was very disconcerting to be preparing for a closing and not be 100% confident that I was going to be awarded a loan.

Closing Costs

I asked my lender continuously beginning a month prior to closing for an estimate of the total closing costs. He estimated closing costs to be between $1,500 and $1,700. Also, he said he would be able to provide me a better estimate about 30 days prior to closing when he has all of the figures from the seller’s side. Not only did I not get a better estimate 30 days prior to closing, I did not get an estimate at all from my lender. I received no good faith estimate. I called the seller’s attorney and was able to get a copy of the Housing and Urban Development Settlement Statement (HUD) the day before closing. I then called my lender and he still did not have a copy of this HUD statement, which he needed to provide me a good faith estimate of what I needed to bring to the table at closing.

I find it totally unacceptable that I was able to get a copy of the HUD statement prior to my lender. Also, it is totally unacceptable that I did not receive a good faith estimate. Finally, it is absolutely wrong that I was made aware the sum of money that I had to bring to the closing one hour before my bank closes the day before closing. My closing was scheduled for half an hour after my bank opened the next day. Basically, I had a one and a half hour window to secure a certified check once I knew my final closing value, which is very nerve wracking.

Lastly, my lender totally left me out to dry with the final value of the closing costs. He never made it seem like the $1,700 to $1,500 range was only for the lender’s fees. It would have been nice to know that the closing costs also included fees to the title company and various miscellaneous fees, totalling over $4,000!!! The following are all fees that are included in my closing costs: funding fee, application fee, underwriting fee, property inspection fee, tax service fee, courier fee, processing fee, flood certification, closing/escrow fee, environmental lien protection endorsement, condominium blanket 1 endorsement, gap risk update, mortgage exemption certificate, record assignment of mortgage, state regulatory fee and for good measure another courier fee. If that isn’t the definition of nickel and diming you, I don’t know what is.

Conclusion

Maybe I was just naive about what was involved in closing and what to expect for the closing costs. I also think my lender could have helped out a bit more, I mean they should want my money, right? Hopefully, you all have learned from my story and will not experience the same nerve wracking and stressful closing experience that I did.

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Understanding the Mortgage Amortization Schedule

September 11, 2008

In three weeks I’ll be closing on my condo, which is my first foray into real estate. I’ve been spending a significant amount of my time researching mortgages, interest rates, tax repercussions and pretty much everything that has to do with owning a house. I’ve already written about the basics of a mortgage and the recent trend of interest rates. Most recently I have been reading about the amortization schedule of mortgage payments.

Amortization Schedule

The amortization schedule is the complete schedule of all 360 monthly payments (for a 30 year mortgage) and how much of each payment goes towards principal and how much of each payment goes towards interest. The amortization schedule also shows the remaining principal balance. Understanding how to calculate your amortization schedule is critical as it allows you to really understand how dramatically extra principal payments can decrease the amount of interest paid. In the figure below I’ve laid out my potential amortization schedule with an assumed interest rate of 6%.

To make your own amortization schedule, you have to have your interest rate, monthly payment and the remaining principal value. You take your interest rate and multiply it by the remaining principal value. You take this number and divide it by 12 as you are using a yearly interest rate, the result is the interest portion of the monthly payment. Subtract the interest portion from the total monthly payment to get the principal portion. Subtract the principal portion from the remaining principal value and you begin the process over again until you have no principal remaining.

Initially, the majority of your monthly mortgage payment goes towards interest. In fact, the majority of your payment doesn’t start going towards principal until year 19! The total amount paid in interest and principal after 30 years is $488,303.12. $262,067.12 went towards interest and $226,236.00 went towards principal. If you do not make extra payments towards principal and pay according to the amortization schedule you end up paying 2.16 times the original borrowed value.

Extra Payment Per Year

One plan for making extra principal payments is to make one extra payment equal to the monthly payment at the end of each year. This is roughly the equivalent of making a half-payment every two weeks, or the biweekly method. The following figure shows the amortization schedule if an extra monthly payment is paid towards principal at the end of every year.

As you can see the mortgage is completely paid off after 297, which is just short of 25 years. In year 15 more of the monthly payment goes towards principal than interest. The total amount paid in interest and principal is $401,896.27. $208,213.87 goes towards interest and $226,236.00 goes towards principal. Adding one extra payment per year, which goes entirely towards principal, reduces the total amount paid towards the mortgage by $86,406.85. With these extra payments you end up paying 1.78 times the original borrowed value.

There are numerous services that will try to sell you on the biweekly method, which is a great idea, IF you are not being charged a fee to do so. Jonathan over at My Money Blog recently posted about the do-it-yourself biweekly payment method. In addition to saving money on interest and paying your mortgage off sooner, the biweekly payment method has an added advantage for people who are paid biweekly.

Personal Amortization Schedule Plan

I have not decided how I will try to pay off my mortgage. I am not planning on staying in my condo for much more than five years. I’m assuming I will be thinking about a family and will want to move into a house. As you can see above, I will only have paid off $15,000 of principal, which leaves me with just over $70,000 worth of equity in my condo (between $80,000 and $85,000 if I include the incentives that were deduced from the cost of the condo). I would like to have more equity built up in my condo before I move to make my next mortgage less formidable. For this reason I will try to pay off some more of the principal than just following the amortization schedule. I will determine how much extra I will be paying off once I figure out how I can max out my retirement savings and furnish my condo.

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