Shop carefully in pursuit of an oh-so-cheap mortgage

PERSONAL FINANCE

October 06, 2002|By EILEEN AMBROSE

DAVID and Dalia Bromberg didn't expect when they bought their Owings Mills home about a year ago that they would be back so soon in their mortgage banker's office.

But, like millions of homeowners, the Brombergs, enticed by interest rates this year that have fallen to levels not seen since the early 1960s, decided to refinance. "I haven't seen these kind of rates in my lifetime," said 37-year-old David Bromberg.

The couple had taken out a first mortgage at 7.75 percent and second at 9.25 percent when they bought their four-bedroom home, a strategy to avoid paying private mortgage insurance. Last month, they refinanced into a single 30-year mortgage at a fixed rate of 6 percent.

"It's going to save us about $240 a month, which will help pay for our son's private school education," said Bromberg, who expects to recoup the cost of refinancing in 16 months.

Mortgage rates started a downward trend after late March, when the average 30-year, fixed-rate loan was 7.18 percent, according to Freddie Mac. Last week, the rate was 6.01 percent. That means homeowners taking out a $150,000 mortgage now will pay $116 less a month than those who took out a similar loan six months ago.

Homeowners are doing the math, and more than 75 percent of mortgage applications now are refinancings.

"I just called the mortgage broker we use and asked for more business cards. I've been handing them out like popcorn," said Peg Downey, a Silver Spring financial planner.

"Everyone is seeing rates with a `5' in front of them, which we haven't seen since the '60s, and are jumping on the bandwagon to refinance," said Kathleen Elliott, senior loan consultant with Advantage Home Mortgage Inc. in Potomac.

But as attractive as the rates are, Elliott added, refinancing may not be right for everyone. "They need to determine if this makes sense for them based on their goals," she said.

For example, a homeowner with only a few years left to pay on a mortgage won't benefit by a drop in rates because the small savings would be gobbled up by closing costs, she said. But it may be a good idea for another homeowner in a similar situation to borrow more in a refinancing and take out cash to pay for home improvements, she said.

As refinancing costs have come down and loan amounts have gone up, it doesn't take a significant drop in rates to make refinancing pay off. But homeowners still must make sure they will be in their home long enough to recoup closing costs. For example, if refinancing saves $200 a month and the closing costs are $2,000, it will take 10 months to break even.

Other factors to consider:

Length of loan. The 30-year mortgage remains the most popular, although lenders say a growing number of homeowners are switching to a 15-year loan.

"It boils down to cash flow," said Gaithersburg financial planner Christopher Brown.

A 15-year loan will have a lower rate than the 30-year, but the monthly payments generally are one-third higher because the borrower is paying off the loan sooner. The shorter-term mortgage, though, saves tens of thousands of dollars in interest over the loan's life.

Homeowners who can't consistently shoulder the higher payments or need money for a 401(k) or college tuition should choose the 30-year loan, Brown said. If they have extra money, they can always apply it to the principal to pay off the loan sooner, he added.

Adjustable vs. fixed rate. There are all types of adjustable mortgages. Sometimes a loan may have a lower rate that's fixed for, say, three or five years and thereafter can be adjusted annually within certain limits. Some adjustments can't exceed 2 percentage points a year, with increases capped at 5 percentage points. Others can have larger initial adjustments.

Usually, homeowners take an adjustable rate because they think rates will fall or they know they will sell the house before they can be hit with higher rates, Elliott said.

But most refinancers are choosing a fixed rate to lock in today's low rates, experts said.

Taking cash out. Some homeowners may increase their loan amount and take some cash from the refinancing. This can be a good, low-cost source of funds if you're building an addition to the home or paying for child's college, experts said. The interest paid also can be deducted on federal tax returns.

Some homeowners, too, are using this cash to pay off high-interest credit card debt. Experts are reluctant to advise this unless homeowners change their card behavior.

"The person has to be disciplined," otherwise credit card troubles can resurface and the homeowner has "no place to go next time," said Chip Reichhart, regional president of First Horizon Home Loans in Baltimore.

Costs. Closing costs generally run $1,500 to $2,500, although some lenders offer "no-cost" refinancings where they pay the fees in exchange for homeowners accepting a higher rate.

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