Real Estate Matters

When does refinancing make more sense than a loan modification?

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By Ilyce R. Glink and Samuel J. Tamkin
Saturday, January 16, 2010

Q: Last February, we got a loan modification with our lender, and I am wonder whether it would be a good idea to try to refinance with them. I am considering a refinance because there were about $3,000 in fees that we weren't able to put into the modification. Could the mortgage company just make the $3,000 come due at any time?

A: You've obtained a permanent loan modification? Good for you. You're part of a tiny minority of homeowners.

The real question is whether you are better off with the loan modification or with a new loan. Will your monthly payments be lower with a new loan? How much would you pay to refinance? What is your current balance, and how many years are left on the loan? Would refinancing cause you to pay more over the long run?

If your lender gave you a permanent loan modification and reduced your interest rate substantially, you might be better off with your current lender than trying to refinance your loan -- especially if you don't have much equity.

If you determine that your loan modification did not reduce your payments by much, you have significant equity in your property and your income supports the payments on a new loan, then you could consider refinancing -- but only if you can get the interest rate reduced substantially, the costs to refinance can be recouped in six to nine months and you don't increase the number of years left to pay off the loan.

Some homeowners make the mistake of refinancing to get a lower monthly payment but then find that the new loan requires them to pay for many more years. The net effect of refinancing a loan should be to get a lower payment while keeping the remaining term of the loan the same.

For example, if you are seven years into a loan and refinance into a 30-year mortgage, your monthly payments may be lower but you have added seven years of paying.

You should use a loan calculator to determine what your monthly payment would be with the new interest rate if you had to repay that new loan off in the same 23 years that you have remaining on the current loan. If you're still saving money monthly, refinancing may be right for you. If your monthly payments would be higher, refinancing may cost you more over the long term.

You also should keep in mind that your monthly loan payment should not include what you pay for insurance or real estate taxes. Your monthly mortgage payments should only be what you pay your lender for interest and principal payments.

You also asked about the $3,000 in fees that you incurred to modify your loan. Your loan documents should specify how that money was accounted for. It may be that the $3,000 will be added to the loan balance and that you pay it off over the life of the loan. It would be unusual for the lender to have the right to immediately request the money.

You should also look at your credit history and credit score. Many lenders reported borrowers who went into a temporary loan-modification program as making only partial payments, despite promising borrowers who were already paying on time that they would be reported as such.

Q: We're interested in buying a condo hotel property as an investment. Our lender told us that we could not buy the unit as a second residence and therefore could not get a 30-year, fixed-rate loan at today's low interest rates.

The condo hotel has an excellent financial track record and rental history. We love the complex and location. But the best loan terms we can find are for an adjustable-rate mortgage. The loan is a 7/1 ARM at 6.5 percent with a 25 to 30 percent cash down payment.

We've always been afraid of ARMs, but we could pay off the loan in seven years by borrowing from our 401(k) or doing a 1031 exchange. Any thoughts on this loan or the investment property plan?

A: Condo hotels became extremely popular as the frenzy over traditional timeshares faded. The hook is that you're buying a specific unit, which the hotel will rent out for you when you're not there and share the income after expenses. It's an arrangement that can be fraught with problems. Some real estate investors consider condo hotels to be a good deal for the initial developer and the condo hotel manager but probably not a good investment for the individual unit owner.

Hotel occupancy is down dramatically, and in some areas, there is a glut of rooms. What if the hotel isn't rented out to the level that was promoted during your sales pitch? And what's your exit strategy? You say that you could do a 1031 exchange -- sell the condo hotel and use the tax-deferred exchange to buy another investment property. But what if you can't sell your condo at that time?

It might be less expensive to simply rent a room in the nicest hotel in town than to buy and finance a condo hotel investment. I've run the numbers on a few of these deals, and once you factor in the fees, maid service, repairs and upgrades, the only one who has done well is the developer.

Do I think this is a good financing deal? I don't know. It sounds reasonable for what you're getting. I like the fact that you could pay off this purchase in seven years. I don't like that you might need to use cash from your 401(k) to do it.

Ilyce R. Glink is an author and nationally syndicated columnist. Her latest book is "100 Questions Every First-Time Home Buyer Should Ask." Samuel J. Tamkin is a real estate lawyer in Chicago. If you have questions for them, write to Real Estate Matters Syndicate, P.O. Box 366, Glencoe, Ill. 60022, or contact them through Glink's Web sites, http://www.thinkglink.com and http://www.expertrealestatetips.net.


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