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When Refinancing, You'd Better Shop Around

By Benny L. Kass
(c) The Washington Post
Saturday, July 22, 1995; Page E22

Q: For some time I have been wondering if I should consider getting a 15-year mortgage because I do not want to be burdened with a mortgage after I retire.

I would appreciate your advice on the advantages and disadvantages of the 15-year mortgage versus the 30-year mortgage, since this is all very confusing to me.

A: You have asked two very different, yet important questions. One deals with a 30-year versus a 15-year mortgage, but the second one -- equally important -- goes to the question of when and whether to refinance.

Let's take the refinancing question first. You indicate that you have a 9.25 percent FHA loan, which you took out in 1988. To switch to either a 15-year loan or a new 30-year loan, that means you would have to refinance. Before you even consider switching mortgage loans, take a look at the interest rates currently available in the marketplace.

In the past few months, interest rates have started to slide. Today, you probably will be able to get a loan at about 7.5 percent. But do not forget that when you refinance, you have to go through a new settlement. You may have to pay points and other closing costs for your new mortgage.

In some Washington area jurisdictions you may have to pay a recordation or transfer tax if you borrow more than the original loan amount. If you have to pay points, keep in mind that each point is 1 percent of the loan amount; if you were to refinance for $100,000, you may have to pay somewhere between $1,000 and $2,500 in points alone for the privilege of refinancing.

Thus, under current market conditions, with your existing loan, it probably makes sense to shop around to determine what is available to lower your interest rate. The general rule of thumb is that until rates come down at least two full percentage points below your current mortgage, it does not make sense to refinance. However, this is only a general rule; each homeowner must make the decision based on the facts of a particular transaction.

The second part of your questions relates to the advantages and disadvantages of a 15-year loan compared to a 30-year loan.

I must state at the outset that I am biased against the 15-year loan. While there have been many real estate analysts who have praised what they believe to be the benefits of a 15-year mortgage, in my opinion, such a mortgage rarely makes sense for the average homeowner.

Let's look at this example. You want to compare a $100,000 loan to be amortized on a 30-year basis as compared to a 15-year basis. While there are lenders who may give you a slightly lower interest rate if you take a 15-year loan rather than the 30-year note, for comparison purposes, let us assume that both loans will cost 7.5 percent.

To amortize the loan over 15 years, your monthly payment of principal and interest will be $927.02. On a 30-year basis, it would be $699.22. That is a $227.80 cash savings per month on a 30-year loan. On a yearly basis, this is a savings to you of $2,733.60.

Keep in mind that so long as Congress does not change the tax laws, the interest deductions for tax purposes will, by and large, be the same for the first few years.

However, as your principal balance goes down faster with a 15-year amortization, accordingly your interest payments will also be smaller.

Thus, the major benefit of the 15-year loan is that you will save a lot of interest over the life of your mortgage. On the other hand, you are also putting up, in our example, more than $2,700 more a year toward principal, thereby reducing your mortgage balance and building up your equity.

Equity is the difference between the market value of your house and the mortgage or mortgages which you owe. In good real estate market conditions, property values increase on a yearly basis as much as 10 to 15 percent, although that certainly has not been the case in the last few years in the Washington area.

Even in bad times, we all hope that property values will at least keep up with inflation, although obviously there will be dips and decreases in market values on a periodic basis.

But assuming that we anticipate growth over the next decade, the equity in your house will grow regardless of the amount of your mortgage. This equity is "dead equity" and in my opinion, you might as well be taking that extra $2,700 and burying it in your back yard.

In effect, that is my analogy for the 15-year mortgage.

I would rather take the extra $2,700 a year and invest it. I could put it in a pension plan, I could invest it in the stock market, I could give it to my children, or I could spend it on a vacation with my family.

After all, what will you do with your house 15 years from now when your mortgage is paid in full? I know of too many people who are currently house rich and cash poor.

When you are in retirement, you may not keep your house, or if you do, you want to make sure that you also have a nest egg to be able to enjoy your retirement years. If you have put all of your money into your house, and then you retire, you may not be in the financial position to tap into that equity at that later date.

Accordingly, in my opinion, take the extra $2,700 a year and invest it in a conservative, long-term investment for the next 15 years. Even without any computation for interest, this will grow to more than $40,500 in the next 15 years. That will be the start of this important nest egg for a rainy day.

It should also be noted that most mortgage loans in this area do not contain a pre-payment penalty.

If you obtain a 30-year loan, you have the right -- but not the obligation -- to make additional principal payments each month, just as if you had a 15-year loan. But if other investment opportunities are available, you can take these additional funds and add more investments to your financial portfolio, in addition to your house.

The advice I give is obviously general. You are advised to discuss your specific needs, plans and tax considerations with your own financial advisers.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, Suite 1100, 1050 17th St. NW, Washington, D.C. 20036.

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