- - Thursday, October 27, 2011

With interest rates remaining so low and the housing market still anemic, refinance customers abound.

Most homeowners refinance to lower their interest rate, but there are many other objectives that can be accomplished through refinancing, depending upon the homeowner’s particular situation.

I’d like to describe a recent refinance that accomplished a lot of things. A fellow called me to inquire about refinancing an \$84,000 loan he had on a rental property. His current rate was 6.25 percent on a 30-year amortization with 22 years left on the loan. His monthly principal and interest (P&I) payment was \$585.

I explained that refinancing probably would make sense but told him not expect the most competitive terms because the loan was secured against a rental property and the amount was relatively small. I quoted him a rate of 4.625 percent with no points. Closing costs would total about \$2,400.

Does dropping your interest rate from 6.25 percent to 4.625 percent with nonrefundable fees of \$2,400 make sense? Let’s run the numbers.

Rolling the \$2,400 in fees into the loan would result in a new loan amount of \$86,400. The P&I payment on the new loan would drop to \$444 per month at 4.625 percent.

Because he would be saving \$141 per month, the refi makes sense, right? Not necessarily.

Remember, the refinance would stretch out his loan term to another 30-year period. The drop in payment is not just a function of a lower rate, but also the additional eight years of the loan term.

Let’s compare apples to apples. If he were to refinance and make payments over a 22-year term, his P&I would only drop by \$63, to \$522.

Does the refi still makes sense? Probably.

Because the balance on the new loan is \$2,400 more, my amortization schedule tells me it will take seven years before the balance of the new loan catches up to the balance of the old loan if it isn’t refinanced. So at the end of seven years, the borrower is ahead by just \$5,292 (\$63 x 84 months). Not a great deal, but perhaps worth it if the borrower isn’t going to sell or refinance again.

I decided to think outside the box and asked him about his current primary residence. He told me he has seven years and eight months left to pay on a 15-year fixed-rate loan at 4.875 percent. The balance is \$91,000 and his P&I on that loan is \$1,176 per month.

I suggested that he consolidate the two loans and secure a refinance against his primary residence, which contains a considerable amount of equity. He would be able to obtain a more competitive rate because the loan amount would be larger and the refinance would be secured against a primary residence.

I quoted him a 10-year fixed-rate loan at 4.0 percent with no closing costs on a loan amount of \$175,000.

My borrower agreed this plan was a no-brainer. His new P&I would be \$1,771, just \$10 more than the sum of his current payments, and both loans would be paid off in just 10 years. Because there are no closing costs, the loan amount didn’t need to be increased.

The borrower had initial objections because he didn’t want to add more debt to his primary residence. I told him the amount of his mortgage debt was independent from what property secured the loan. If he could obtain better terms by using his primary residence as collateral, he should do so, unless he was in danger of defaulting, which he wasn’t.

It’s always good to think outside of the box.

Henry Savage is president of PMC Mortgage in Alexandria. Send email to henrysavage@pmcmortgage.com.