If your home mortgage carries a double-digit interest rate, don't miss 1988's refinancing boat. It could pull out any time now.
Homeowners who recall last February and March's rate cycle -- or who missed the refinancing boat in early 1987 -- should get ready to make their move. That's because rates are at or near their lowest point for this round, in the view of mortgage-market economists with solid forecasting track records.
"I'd look for another 50 basis-point (one-half percentage point) drop," said Joseph Hu of Shearson Lehman Hutton. "But the bottom is not far away."
Thousands of refinancing-minded borrowers were stranded last year at this time. Despite warnings that 8 1/2 percent to 9 percent fixed-rate mortgages represented the best buys of the year, those owners waited for even lower rates. They're still waiting.
Rates jumped by two points between March and April -- the calamitous spring 1987 "spike" -- and had soared to 12 percent by late September. Only the Oct. 19 Black Monday crash sent them downward again.
No one is predicting a mirror-image rate performance this spring. But the economists' message to refinancers should be clear: Start the loan-application process sooner rather than later if you have a need to convert to lower-rate financing during 1988.
Which raises two related, key questions: How do you know if refinancing will be cost-effective for you given the fees associated with it? And what loan alternatives are most attractive in the current market for people who are refinancing?
Start with the first. The basic rule for sensible refinancing is this: You should be able to drop your interest rate at least 2 percentage points, and you should be able to recoup all the attendant costs in the first 24 months.
Here's an example: Say you have a $100,000 mortgage at 12 percent. Your house has appreciated in value to $200,000 and you see an opportunity this month to accomplish two financial goals. By refinancing to a conventional, fixed-rate mortgage at 9 1/2 percent, you can lower your cost of money by 2 1/2 percentage points and pull out another $20,000 to $60,000 in cash. You can tap the $20,000 to $60,000 extra by refinancing into a $120,000-$160,000 replacement loan.
But what about the cost of paying off your old loan and getting a new, larger one? To calculate whether your rate saving will be cost effective this spring, add up all the charges associated with refinancing. Your lender can supply them before you apply. There will be an appraisal fee, credit and title fees, sundry closing and escrow charges, plus points assessed by the lender. Refinancing charges typically total between 2 percent and 4 percent of the loan amount. For this example, say they total 3 percent.
Then compare the costs of a new, lower-rate loan of the same size as your old loan, $100,000. The cost of switching from a 12 percent loan to a 9 1/2 percent of the same size -- $100,000 -- would be $3,000 ($100,000 x .03).
Your monthly savings on mortgage payments alone would be $188. (Your 12 percent loan cost you $1,029 in principal and interest per month; a 9 1/2 percent replacement loan would cost you just $841). Your savings over a two-year period would total $4,512 ($188 x 24). Those savings easily outweigh the $3,000 costs.
So refinancing a $100,000 loan for 2 1/2 points less is well worth the fees involved. But what about pulling out more than the current amount? Some quick calculations will show you that you can borrow another $22,500 at the 9 1/2 percent rate without raising your monthly payment. A $122,500 new mortgage at 9 1/2 percent would cost about the same per month ($1,030) as your $100,000 at 12 percent.
What about going full bore -- pulling out $60,000 extra? A $160,000 loan at 9 1/2 percent would cost you $1,345 in principal and interest -- $216 more than your current loan. But the refinancing costs would be reasonable for what you're getting. They'd be $4,800 ($160,000 x .03), and they'd come out of the $60,000 proceeds. For $216 extra per month, you'd have use of $55,200 at 9 1/2 percent. Not bad if you can use the cash to add to your home, fund an education or simply have fun.
What about other ways to do a refinancing this spring? There are plenty of attractive alternatives to a 9 1/2 percent fixed-rate loan in most competitive markets. One of the best at the moment is the three-year adjustable (ARM) at 8 1/2 percent with two points up front. If you're willing to take a slightly greater risk on rates, a 7-to-7 1/2 percent one-year ARM will also help your refinancing pencil out.
Whatever you choose, though, start checking it out now. Don't miss the refinancing boat two years in a row.