It's ironic in a way, that while your home is one of your primary assets, the mortgage on that home factors high on your list of liabilities.
It's a fact of life that most homeowners need to borrow funds to pay for their homes, and then spend a good chunk of their lives paying the money back, along with a hefty dose of interest.
Mortgage interest, however, has a huge advantage over car loan or credit card interest. As you probably know, the interest you pay on your mortgage is tax deductible. Every April, you get to note on your tax return the amount of mortgage interest you've paid that year. Deducting the interest payment can significantly lower the amount of money you've got to hand over to Uncle Sam. Financial planners net this figure (interest paid less the tax savings), knowing that being able to deduct mortgage interest lowers the cost of borrowing for the house.
At this point of your life, you may or may not have a mortgage. If you've lived in the same house since you got married when you were 24, you very well may have paid off your mortgage by this time. Many of us, though, are still paying—either on our first home, or because we've moved to a more expensive home and needed to borrow to cover costs.
If you no longer are paying a mortgage, you've hopefully found some other helpful tax deductions. Those who are still struggling with house payments, however, may wonder from time to time whether you've got the best type of mortgage you can. Maybe you've thought about refinancing your mortgage for a lower interest rate. Some folks refinance every time the interest rate drops even the slightest amount. Others regard refinancing as too much trouble, or not worth the money you have to pay to do it.
A lower interest rate isn't the only reason people refinance their homes. Many people refinance to accommodate debt consolidation, or to pay for remodeling, college bills, and so forth.
Adding It Up
Points are expensive and can be a problem if you have to pay them up front. Equal to one percent of the total amount of the loan, one point on a $100,000 loan is $1,000. Three points are worth $3,000, and so forth.
Deciding whether it's worth refinancing your home can be a challenge, for sure. You refinance in order to save money, but how do you know when the interest rates have dropped enough to make it worthwhile? If the drop has been significant, you might be able to refinance into a lower-cost loan, which can put extra dollars in your pocket.
Be aware, however, that just because a loan offers a lower interest rate, does not mean that you'll save money. To refinance a mortgage or equity loan, you'll have to pay title insurance; loan fees, such as a broker's commission and appraisal fee; and points (a fee imposed by the lender that equals a percentage of the loan amount) all over again. These costs can take a big bite out of any savings you'll realize from reduced interest rates and lower monthly payments.
If you're thinking of refinancing, you'll need to find out how much it will cost to do so, and then figure out how long it will take you to recoup those costs. A representative from the lending institution you're using should be able to help you determine that.
When negotiating a refinancing deal, you'll have to decide whether you'll pay the fees up front, or include them in the amount of your loan. There is a type of loan called a no-cost loan, which allows you to waive the up-front costs and have them included in amount of your loan. The interest rate on your loan will increase one-eighth of one percent for every point you opt not to pay at the time you refinance.
If you choose a no-cost loan and pay no points or other loan expenses up front, you can typically expect to pay between half and five eighths of 1 percent higher than you would for the same loan on which you'd paid the expenses up front.
If you plan to stay in the home for more than five years, it's a good idea to pay as much of the loan costs up front as possible so that you can lock in a lower interest rate. Here's why.
Let's say you get a $200,000 loan at 6.7 percent. You pay $5,000 in total loan costs and points. Your friend, however, borrows the same amount of money, but opts to pay no costs up front. His interest rate, as a result, is set at 7.4 percent.
At the end of 10 years, you will have paid about $128,900 in interest, compared to $139,400 for your friend. You'll have saved $10,000 in interest, from which you'll need to subtract the $5,000 you paid for fees at the start of the loan. Still, over 10 years you've saved $5,000.
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Excerpted from The Complete Idiot's Guide to Personal Finance in Your 40s and 50s © 2002 by Sarah Young Fisher and Susan Shelly. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.
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