When to join the refinance rush

Lowest interest rates in nearly two years drive homeowners to seek better mortgages

If you haven't yet heard the call of the mortgage lenders, you will.

Many consumers are already answering.

One index of mortgage-loan applications jumped 15 percent for the week ending March 2 over the prior week, according to the Mortgage Bankers Association of America, which released the figure last week.

Many of those applications are for the refinancing of existing loans. Amid sliding interest rates, refinancing is especially hot.

"In a normal year, 20 percent of mortgage originations are refinances, now it's about 60 percent," says Guy Cecala, publisher of Inside Mortgage Finance, a weekly newsletter based in Bethesda, Md.

Mr. Cecala thinks the first half of this year may be the best time to refinance. "I think rates will hover at or just below 7 percent through June, but I would look for increasing rates after that."

Borrowers may be motivated to refinance for several reasons. The most obvious reason: that lower rate. A second reason might be to trade an adjustable-rate loan for a fixed-rate loan, or to change the loan's term. And often a third reason is to consolidate debt.

Scott McCrea of Melbourne, Fla., refinanced for all of these reasons. He and his wife didn't waste any time when they saw interest rates drop.

"I watched mortgage interest rates on the Internet, and when my credit union showed that rates reached my target of 7 percent, I called and locked in the rate," says Mr. McCrea. "I wanted to consolidate a first and second mortgage and pay off some credit-card debt we had incurred for home repairs."

McCrea went for a 20-year loan. "It will save us lot of interest over the long run," he says.

Anyone seeking to refinance should first make some key calculations, experts say. Loan amounts and tax brackets play important parts in the formula.

"It usually takes at least a 1 percent drop in your interest rate to justify the cost of refinancing. If you aren't paying yourself back for the cost of refinancing in two years," says Cecala, "it's probably not worth it."

For example, if it costs $3,000 to refinance and your monthly mortgage payment drops by $100 a month, the payback period would be 30 months ($3,000 divided by $100). That's too long according to Cecala's guidelines.

And make certain your savings are what you think they are. While your cash flow in the example above may increase by $100 a month, your real savings should be computed after taxes.

Remember, a lower interest rate often means you have less interest to deduct come tax time. If you have a 15 percent effective tax rate, and your refinance reduces your mortgage interest by $1,200 in the first year, your income-tax bill would increase by $180.

That means you will really only save $85 a month after taxes. Do the math again. Take $3,000 divided by $85 - and the payback period is 33.3 months.

Since taxes are such an important part of the payback calculation, consider the effect President Bush's tax-cut proposal might have. John McGowan, chairman of the accounting department at St. Louis University, notes "the impact of any income-tax reduction will also reduce the value of mortgage interest as a tax deduction."

For example, if you currently pay $10,000 a year in interest on your mortgage, and your effective tax rate were decreased by 3 percent, your mortgage interest deduction would provide $300 less of a tax benefit after the tax cut.

Regardless of the tax effect, one way to reduce the payback period is find a loan with reduced costs. Mr. McGowan points out some mortgage companies may refinance loans without closing costs. "In this model, it would always be desirable to refinance at any lower rate, since you'd break even immediately."

Rich and Debbie Petrosh found a deal in which refinancing fees were included in the new mortgage. From the first payment they were saving about $130 per month.

"Refinancing at this point is a no- lose," says Mrs. Petrosh

Still on the fence? You might consider some alternatives to refinancing:

* Many adjustable-rate loans have a "conversion" clause that allows the borrower to convert to a fixed-rate loan by paying a small fee.

* Consider a home-equity loan to consolidate debt or make home repairs. Most lenders charge no closing costs on these types of loans. You will pay a higher interest rate and the maximum loan term is usually less than 20 years.

* If your objective is to pay off your mortgage earlier and save interest, you can pay an extra $100 a month and pay off a typical 30-year mortgage in about 22 years. But first check with your lender to be sure your loan does not have a prepayment penalty.

(c) Copyright 2001. The Christian Science Monitor

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