Equal Home Finance Bureau ALERTS!

How Do We Know if We Should Refinance?

Dear Equal Home,

We have been in our home for 21 years and have 9 years left on a 30 year loan. The interest rate is 9%. We originally obtained our home loan through Farmers Home Administration, but they have since sold the loan to another bank.

At present time we have aprx. 23,000 left on the loan and were thinking about refinancing. We have checked with 2 lenders, so far, one is at 8% with $600 cost for closing, the other is 6.875% with around $1200 closing cost. We are not looking to lower our monthly payment just trying to save some interest money.

Is it wise for us to spend between $600 or $1200 on closing costs to obtain a lower interest, or would we be better off to use $600 to 1200 and just pay on our present mortgage. We would like to pay off the mortgage as scheduled in 9 years whichever way we go.

Thank you for your help in this matter.

D.W. in the Heartland

Dear D.W.,

Thank you for your question.

9% is certainly a high interest rate, but on an extremely low mortgage balance, the decision to refinance can be much more difficult. Here are some issues for you to consider.

One thing to be wary of is hidden costs. Whether you are doing a refinance or getting a new loan, the comparison shopping process must be handled with great diligence and with sufficient time. Our experience tells us that there is great potential for you to be surprised with other fees than the closing costs you mentioned. Further, it is unlikely that you would be able to find a loan with a 9 year term. Many lenders and mortgage brokers attempt to slip in "prepayment penalties" that make it financially impossible to accelerate your payments on a 15 year or 20 year mortgage loan, forcing you to extend the life of the loan, paying a lower interest rate, but certainly much more total interest. There is also the chance that last minute fees and other costs will come in at the closing table, if you're not very careful about what you sign and read through all documentation very carefully.

Another trick used by lenders is to give the consumer low upfront closing costs, no prepayment penalties, but bury extra costs in the loan balance itself, so that you end up with a lower interest rate, but a higher loan balance to pay off. Given that it could be 21 years since you last went through the mortgage lending process, you might be surprised at the potential costs that can be buried in loans today.

The problem with all of this is that the person you are asking about the loan is the person that is getting paid for getting you the loan in the first place. There is an obvious conflict of interest. You have to be able to do your own homework to answer these questions, unfortunately.

So, the loans you described in your email must have absolutely no other costs than the ones you described. You must be certain there are no prepayment penalties (and make sure you get that information in writing prior to going to the closing table, and when you get the loan). You have to be certain that you will be able to read through all of the documentation to be absolutely sure you are getting the exact loan that you think you are getting. Read through our ALERTS! and articles at our web site for some real stories of consumers and the terrible practices of shady lenders and brokers.

Even if you are certain of all of the above, it's possible that your actual interest savings (depending on things like tax deductibility of interest, etc.) may only be a couple thousand over the entire nine years even with the low 6.875% loan. The interest savings on the 8% loan, given the upfront $600 cost is much smaller than even that.

Some consumers in your position, with very low loan balances in the final years of loan repayment, have opted to avoid the risk of getting a new loan and making upfront closing costs. Instead, those consumers have simply made an aggressive commitment to paying down their existing loan early. The money that would have gone to closing costs on a new loan goes to additional payments on the current loan, effectively reducing the term of the loan, and the interest that would have been paid otherwise.

With such limited information in an email, of course, and not knowing the lenders and brokers you are dealing with, nor the tax implications of your interest payments, it would be difficult to provide too specific a recommendation. However, we hope that this discussion provides more insights into your question.

Thank you,
The Equal Home Finance Bureau

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