Questions to answer before refinancing

Posted by Mark Chapman on July 25th, 2010 at 1:28 pm

Dane Hahn

By Dane Hahn

The Realty Column

My Doc­tor used to tell me that even when he was in the gym, peo­ple who knew him would come over to the machine he was using and ask med­ical ques­tions. He felt he was never away from giv­ing advice, and so it is with real estate and me. This week I had a chance to visit an old friend in Mary­land. The con­ver­sa­tion came around to real estate, and her ques­tion was, “ is this a good time to refinance?”

As my read­ers already know, we are at a 50-year low in the rates avail­able for mort­gages. And now is the time to refi­nance — unless you are plan­ning to sell in the next year or so or are already at last year’s very low rate. As I write this, the rates are in the mid 4’s and are likely to be steady or go up slightly as we come to the end of  sum­mer. But, as a caveat, my crys­tal ball has been a lit­tle cloudy recently.

Still, as we eval­u­ated her sit­u­a­tion, she had lots of ques­tions, and the answers to them might help oth­ers who were in sim­i­lar sit­u­a­tions. In her case, she is a sin­gle woman, four years from retire­ment — she’s a school­teacher — and she owns a very nice con­do­minium. She had taken the first step in refi­nanc­ing; she had called her bank, Wells Fargo, and dis­cussed a refi­nance with them. They had sent her a pile of paper­work and quotes for a 20– and 30– year mortgage.

She still has 20 years left on her 30-year mort­gage, so she won­dered if she should get a new 20-year mort­gage, or go back to 30 years. Her con­cern was that she would be 91 when a 30-year mort­gage was finally paid off. But a more impor­tant con­cern is how would you pay for the mort­gage after retire­ment? So my feel­ing was that the 30-year mort­gage is a bet­ter choice because the monthly pay­ment would be sev­eral hun­dred dol­lars lower than that of the 20-year pay­ment. The like­li­hood was she would prob­a­bly sell the unit in the next seven to 10 years, so the smaller pay­ment was more impor­tant than the length of the term.

Because she has sig­nif­i­cant equity in the unit (she bought it 10 years ago), she won­dered if she might take money out. Actu­ally, this was a ques­tion the mort­gage agent from Wells Fargo asked her. My answer: NO. She could, of course, take out some cash, but as she is OK with her mod­est finan­cial needs, there is no rea­son to, and that would sim­ply increase her monthly payment.

But then the con­ver­sa­tion wan­dered into terms that were com­mon to the real estate indus­try, but were not so com­mon in every­day lingo. We went through her monthly state­ment and dis­cussed each one of the head­ings — and I was inter­ested that no one had ever explained them to her.

So for the record, here they are, in no par­tic­u­lar order:

Your monthly pay­ment to the bank or mort­gage com­pany is gen­er­ally PITI. Which is Prin­ci­ple, Inter­est, Taxes and Insurance.

Prin­ci­ple is the amount you bor­rowed (when you got the loan), and, in the monthly pay­ment, it is the por­tion of that pay­ment that is applied to repay amount you bor­rowed. Peo­ple are often sur­prised at how small the monthly prin­ci­ple pay­ment is, and then how slow these lit­tle pay­ments erode the total amount due. This is why aggres­sive bor­row­ers often send in a 13th monthly pay­ment marked “apply to prin­ci­ple.” So folks do it when they get their IRS return check, oth­ers when they get a bonus or some other windfall.

Inter­est is the cost of the money you bor­rowed. In a 30-year mort­gage, the pay­ments are fixed for the life of the loan, but the inter­est is “front-loaded,” mean­ing that as the years go by, the amount of inter­est paid in any year decreases and the prin­ci­ple increases. For the last 100  years or so, the inter­est has been deductible from your fed­eral income tax. It was the deci­sion of Con­gress with heavy lob­by­ing from the National Asso­ci­a­tion of Real­tors to make this inter­est expense a ben­e­fit of home ownership.

Taxes: Gen­er­ally your lender will escrow an amount of money so when your munic­i­pal taxes are due, either the bill goes to the lender directly, or, when you get the bill, you mail it to them and they will have enough money in your “tax escrow” account to pay the taxes. Remem­ber, even though you own the house, the munic­i­pal­ity in which the prop­erty is located has the right to take the prop­erty for taxes if the taxes are not paid. The lender does not want this to hap­pen because they also have the right to fore­close if you have not paid the mort­gage pay­ment. So it is in the lender’s best inter­est to know for sure that your taxes are paid. That’s why they want to make your payment.

Insur­ance: You will have to keep the home insured as a con­di­tion of the mort­gage. No lender wants a mort­gage on a house that has burned down. Usu­ally, when you are sign­ing up for a new loan, the lender will require you to get insur­ance and pay for a year’s worth of cov­er­age, then give them the invoice marked paid. They will then deter­mine the monthly cost of the pol­icy and add that amount to your pay­ment. Again, they do this so that they will have the money in your account when next year’s insur­ance is due.

Escrow: This is a term for an account held in your name with your lender. It is the account in which the monthly pay­ments for taxes and insur­ance are held. So folks may also have a home­owner or condo fee placed in the escrow account, so the bank would make that pay­ment as well. When the prop­erty is ulti­mately sold (by you), the bal­ance of that account is sup­posed to be paid to you; this has been an issue for some folks, and they have had to pester the lender to get the bal­ance out and returned to them.

Equity: This is the amount of own­er­ship you have in the prop­erty. For exam­ple, regard­less of what you paid for a prop­erty, equity is deter­mined on the present-day value. So if the home is worth $200,000 today, and you still owe $125,000, in sim­ple terms you have $75,000 in equity. There are costs of sale and the val­u­a­tion may or may not be what the actual sale price winds up being, but equity is what you would still have when the sale is over.

—

Dane Hahn is a Real­tor, Broker/Associate with Tar­pon Coast Realty. If you would like to dis­cuss real estate or per­haps engage him as a Real­tor, please call 603−566−5460.

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