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The Ins and Outs of Mortgages and
Refinancing
There was a time when mortgages were a fairly straight
forward instrument. There were 30-year, fixed rate mortgages and
nothing else. Today, however, there are more than 200 different
types of mortgages, including those with adjustable-rates,
according to a recent Journal of Financial Planning article
written by George Collis, CFP®,
According to Collis, financial planners must now view
mortgage fact-finding, analysis, and recommendations as a
central aspect of comprehensive financial planning, not as an
afterthought. "Mortgage options have direct implications
for cash flow, risk management, asset accumulation, retirement,
and legacy planning," Collis wrote earlier this year.
And part of the fact-finding includes helping those seeking a
mortgage or refinancing to navigate the tricky shoals of
applying for and securing the best possible terms, according to
David Reed, author of "Mortgages 101," and
"Mortgage Confidential." Here, according to a recent
release, is what Reed and other planners say homeowners and
would-be homeowners need to know about mortgages and
refinancing:
To get the best deal on a mortgage, planners recommend
working with a lending officer who understands your needs. Spend
time getting clear on the difference between features and
benefits; choose the loan that offers you 1) the greatest
benefit for you, 2) at this time, and 3) in these circumstances.
Be very clear about that, and be prepared to ask for options
that address your agenda, not the loan officer's. If the lending
officer can't address your questions and needs, find another
lending officer.
Don't wait until rates are 2 percentage points below your
current rate before you refinance. While the "2 percent
rule" seems to have been around forever, Reed suggests that
it simply doesn't make sense. To determine whether or not a
refinance is worth your while, consider both the new monthly
payment and the associated closing costs that will accompany the
new loan, he says. You do this by taking the difference between
the current payment and the projected new payment, and dividing
the closing costs (exclusive of amounts to fund the new escrows)
by the monthly savings. If you plan to hold the mortgage for
more months than that number, you're ahead by refinancing. A
more refined analysis will use the after-tax cost of the monthly
payments instead of the nominal costs. There are, of course,
many factors beyond the loan interest rate that should be
considered when making a decision to refinance. Often, the most
significant factor is cash flow.
Cash-out refinancing can cost you more than you think.
Typically, a homeowner might refinance their current mortgage
and pay off their credit cards, car loans, or other debts. But
Reed suggests that doing so only works on paper. To be sure, the
homeowner has gotten rid of their car payment. But what was once
a four- or five-year note is now stretched out over 30 years.
The bottom line is this: Consider a cash-out deal only if you
were going to refinance your mortgage anyway because of the
lower rates available. Don't do it because some loan officer
showed you how much lower your payments would be if you
consolidated your bills, unless short-term cash flow is one of
your concerns going into the refinance conversation. For the
purpose of tax deduction of mortgage interest expense, IRS
classifies two types of mortgage: acquisition and home equity.
Converting an acquisition mortgage into a refinance changes the
classification and that may impact what amount of interest can
be deducted.
Reed also recommends learning what the mortgage lingo means.
Know, for instance, the difference between loan
prequalification, pre-approval, and approved with conditions. A
loan prequalification, or "prequal," letter simply
states that you've had a discussion with a loan officer.
Pre-approval letters are issued after credit approval has been
obtained either from an automated underwriting system (AUS) or
from a human underwriter. This is a pre-approval because a full
approval is not issued until a full loan package is submitted
for review — which includes an acceptable property appraisal and a
ratified contract. Some realtors will accept a prequalification
letter, while others want a pre-approval letter.
Know the difference between "clear to close" and
funded. When all the conditions have been signed off on,
everything is in order, the property has been evaluated, and
your loan papers have been printed, you're clear to close. Your
new home isn't officially yours, however, until your loan has
been funded, and the deed has been recorded. Typically, the
funds aren't wired to the borrower. They are wired to the
closing agent, who brings the funds to the closing where they
are then given to the seller upon completion of the signing. Of
note, the terms are not universal. In some states the language
would be as follows: When all "prior to" conditions
have been met the loan is characterized as "clear to
close." That means the closing department can draw loan
documents and transmit them to the title company for the
closing.
Lastly, ask your lender about your loan's "yield
spread". Yield spread is a commission paid to the loan
officer by the lender, and it can amount to thousands of
dollars. Knowing that the loan officer stands to receive a large
yield spread will give you more room to negotiate lower closing
costs such as origination fees and document preparation fees.
These fees, called "junk fees", often provide
tremendously high margins, and therefore may be negotiated if
the loan officer is getting paid elsewhere.
December 2006 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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