Refinancing your home: saddled with a double-digit mortgage? It's not too late to save thousands on your home loan

Black Enterprise, Dec, 1993 by Steve Bergsman

When Mary Walker bought her $200,000 home in 1988, the interest on her 30-year fixed-rate mortgage was an onerous 13 1/2%. Four years later, she refinanced her loan, bringing the rate down to a more manageable 9.5%. Then this past summer, with interest rates plunging to a 25-year low, Walker refinanced her Mitchellville, Md., home once again. But this time, she went for an adjustable-rate mortgage (ARM), an option that seemed irresistible with its initial rate of just 4.5%.

Why the third round of refinancing? Thanks to her new ARM, her monthly payments will drop by nearly 34%--from $2,462 to $1,619. She could have taken a 30-year mortgage at 6.8% with a monthly payment of $2,000. But the 16-year veteran of Digital Equipment Corp. recently left her position as sales program manager to start New Horizons Consulting, a marketing and consulting company. "I figured I would need as much capital as possible to get my business off the ground," she says.

Walker is one of a slew of homeowners who've jumped on the ever-more-popular refinancing bandwagon. Just when everyone thought rates had bottomed out, 30-year mortgage rates fell below 7% in September--their lowest point since 1968. The result was a new wave of homeowners rushing to refinance--some, like Mary Walker, for the second or third time within two years.

Any homeowner paying above 8.5% interest is a good candidate for refinancing, says Terry D. Gray, chairman and president of Community Lending Corp. In College Park, Md. Also, experts advise that you plan to be in the home for at least four years. "Otherwise, you won't be able to recoup closing costs and fees that could eat up as much as 3% of the loan," says Gray.

YOUR OPTIONS

Right now, the average rate on traditional 30-year loans is about 6.8%, compared with 9% in 1991. Rates on 15-year fixed mortgages average 6.4%. No doubt, a 30-year fixed-rate mortgage is more common. But as rates become more attractive, some homeowners are smartly opting for shorter loan terms. Granted, there are issues to consider when cutting your payback time in half. But a quick look at the math shows that the tradeoff--higher payments over a shorter period--is well worth it: By paying off a $100,000 loan over 15 years instead of 30 (see chart), a borrower stands to save a staggering $79,742 in interest payments alone.

MORTGAGE MANIA

Nationwide averages for fixed- and adjustable-rate mortgages on a $100,000 home loan.

                                                    QUALIFYING
                                       TOTAL          GROSS
MORTGAGE         AVERAGE  MONTHLY     INTEREST       MONTHLY
  TYPE            RATE    PAYMENT    PAYMENTS        INCOME
30-Year Fixed     6.84%    $654.59   $135,653.02     $2,337.82
15-Year Fixed     6.41%    $866.17   $ 55,910.13     $3,093.47
Adjustable Rate   4.18%    $487.85   $ 75,626.22(*)  $2,376.07(**)

(*)Calculations based on initial rate of 4.18% only, rate and interest payments subject to rise.

(**)Under current Federal National Mortgage Association and Federal Home Loan Mortgage Corp. regulations, borrowers must be qualified to borrow money at a minimum rate of 7%; interest would be paid at the regular rate of the mortgage.

Source: HSH Associates, Butler, N.J., September 1993.

"In most cases, homeowners break even with their existing mortgage payments while cutting the time in half," says Gregory St. Etienne, executive vice president at Liberty Bank & Trust Co. in New Orleans. Take, for example, a homeowner currently paying a 10% interest rate on a 30-year mortgage for a $100,000 home. That individual refinances with a 15-year rate at 7%. The monthly payment may be $21 more, but the savings over the long term is greater.

The ARM, another option over the 15- or 30-year fixed-rate mortgage, is fast coming back into favor. With an ARM, interest rates flucturate depending on various economic conditions and indicators, such as CD rates and Treasury yields. In turn, monthly payments are "adjustable." Lenders usually charge lower initial rates for ARMs than other loans, because the homeowner shares the risk if interest goes up.

ARMS are attractive to borrowers because they offer a lower monthly payment for a limited period of time, observes Gray. The lower monthly payment lets you recoup from the closing costs associated with refinancing or keep household expenses down until you are in a better financial situation. This explains why ARMs are inviting to younger homeowners who expect their salaries to grow significantly. Even so, most lenders look to "qualify" homeowners at a rate that's about two percentage points higher than the initial, or teaser rate. In other words, their gross monthly income must be sufficient to sustain payments at the higher rate.

While ARMs vary from bank to bank, there are a couple of key features that homeowners should watch for:

* How quickly do rates change, and is there a ceiling, or cap, on how much the rate can rise within a given time-frame? For the first six months the interest rate on most ARMs are fixed. Thereafter, rate increases may be capped at 2% for one-to two-year periods. So, even if your ARM has an initial rate of 4.5%, the worst to expect would be a rate of 6.5% after a year or two.