Refinancing Information
Adjustable-rate Mortgage (ARM): A mortgage loan with an interest rate subject to change over the term of the loan. The interest rate is tied to the performance of a specified market rate, such as the cost of funds index calculated by the 11th District of the Federal Home Loan Bank Board, or the yields on one-year or six-month U.S. Treasury securities.
Amortization: The paying down of principal over time. In a typical mortgage loan, the principal is scheduled to be paid off, or fully amortized, over the term of the loan.
Average Hourly Earnings: A monthly reading by the Bureau of Labor Statistics of the earnings of hourly plant and nonsupervisory workers in the private sector. While the AHE excludes salaried workers (unlike the employment cost index), it is available each month with only a brief lag. Released by BLS as part of the Employment Situation release, the report is generally issued on the first Friday of the month for the prior month.
Basis Point: One one-hundredth of a percentage point. For example, if mortgage rates fall from 7.50% to 7.47%, then they've declined 3 basis points. A full percentage point is 100 basis points.
Cash-out Refi: A refinancing of a mortgage in which the new principal (the borrowed amount) exceeds the outstanding principal of the original loan by at least 5%. In other words, the homeowner is taking equity out of the home. Of the mortgages it owned that were refinanced during the first three quarters of 2000, Freddie Mac estimates that more than 4 out every 5 were cash-out refis.
Conforming Mortgage Loan: Any mortgage loan that's at or below the amount that Fannie Mae and Freddie Mac can purchase and/or securitize in the secondary mortgage market. For 2001, the loan limit is $275,000. In 2000, it was $252,700.
Consumer Confidence Index: A measure of confidence that households have in the economy. Released by the Conference Board late in the month.
Consumer Price Index (CPI): A measurement of the average change in prices paid by consumers of a fixed market basket of a wide variety of goods and services. The broadest, and most quoted, CPI figure reflects the average change in the prices paid by urban consumers (about 80% of the U.S. population). The so-called "core CPI" excludes the volatile food and energy sectors in an attempt to determine the underlying rate of inflation. Strictly speaking, the CPI is not a "cost of living" index because its fixed market basket does not allow for the substitution of goods and services due to price changes. The CPI is released by the Bureau of Labor Statistics in mid-month for the previous month.
Conventional Mortgage Loan: Any mortgage loan not guaranteed or insured by the government (typically through FHA or VA programs). Employment (Payroll): The number of nonfarm employees on the payrolls of more than 500 private and public industries. Generally issued on the first Friday of the month for the previous month by the Bureau of Labor Statistics, and one of the most watched economic indicators in the financial markets.
Employment Cost Index: A quarterly index used to gauge the change in the cost of civilian labor. Unlike the average hourly earning measure, the ECI includes salaried workers. Another advantage of the ECI is that changes in the index are independent of shifts in the composition of the workforce (that is, the index is not affected by, say, a surge in the number of lower-paying jobs relative to high-paying jobs because it uses fixed employment weights. Instead, the ECI reflects the change in the employment costs of the same set of jobs). The index has two major components: the wage and salary series and the benefits series. The survey is conducted during pay period including the 12th day of March, June, September and December. The Bureau of Labor Statistics releases the results about six to seven weeks after the survey period. The less comprehensive average hourly earnings figure is a more timely indicator, as it's released monthly, usually within a week after month's end. Existing Home Sales: Based on the number of closings during a particular month. Because of the one-to-two month period between a signed purchase contract and a closing, existing home sales are more influenced by mortgage rates a month or two earlier than the prevailing mortgage rate during the month of closing. New homes sold, on the other hand, are counted when the purchase contract is signed. The reported figure is generally a seasonally adjusted, annual rate. Data are released by the National Association of REALTORS? on the 25th of each month (or the following business day) for the previous month.
Fannie Mae and Freddie Mac: The nation's two federally chartered and stockholder-owned mortgage finance companies. Forbidden by their charters from originating loans (that is, from providing mortgage loans on a retail basis), these two Government-Sponsored Enterprises (GSEs) purchase and/or securitize mortgage loans made by others. Due to their directive to serve low-, moderate-, and middle-income families, the GSEs have loan limits on the purchase or securitization of mortgages (in 2001, the conforming loan limit is $275,000). The difference between these two entities often comes down to size (Fannie's larger), business strategy and execution.
Federal Funds Rate: Also known as the fed funds rate, this is the rate that banks charge each other on overnight loans made between them. These loans are generally made so that bank can cover their daily cash flow and reserve requirements. As the rate rises, banks have an increased incentive to keep more of their own cash on hand - making less money available to lend out to households and businesses. The Fed doesn't actually set the fed funds rate, which is determined by supply and demand of the funds; instead, it sets a target rate and, through its own purchases or sales of securities, affects the supply of funds.
Federal Open Market Committee (FOMC): The arm of the Federal Reserve that sets monetary policy, the FOMC is scheduled to meet eight times a year. The 12 members of the FOMC include the seven governors of the Federal Reserve System, the president of the New York Federal Reserve Bank, and, on a rotating basis, four of the presidents of the other 11 regional Federal Reserve Banks.
Fixed-rate Mortgage (FRM): A mortgage loan with an interest rate that does not change over the term of the loan. Freddie Mac: See entry for Fannie Mae.
Gross Domestic Product (GDP): The value of all the final goods and services produced in the U.S. over a particular period. Available from the Bureau of Economic Analysis toward the end of the first month following the end of a quarter, and revised in each of the following two months. Growth in inflation-adjusted GDP, or real GDP, is the figure most often quoted. The GDP figures before adjustment for inflation are known as nominal GDP.
Homeownership Rate: The number of households residing in their own home divided by the total number of households. Late in the month following the end of each quarter, the U.S. Census Bureau releases an estimate based on a quarterly survey. A record homeownership rate of 67.6% was reached in the fourth quarter of 2000.
House Price Index: A quarterly measure of the change in single-family house prices. The HPI is a repeat sales index, meaning that it measures average price changes in repeat sales or refinancings on the same properties, and is based on mortgages purchased or securitized by Fannie Mae and Freddie Mac. Homes with mortgages above the Fannie/Freddie conforming loan limit (in 2001, it's $275,000) are not included in the sampling, nor are homes insured or guaranteed by the FHA, VA or other federal government entity. This index is distinct from the similarly constructed Conventional Mortgage Home Price Index published by Freddie Mac. Indexes are available for the nation, nine Census regions, each of the 50 states and the District of Columbia, and 329 Metropolitan Statistical Areas (MSAs). Released by the Office of Federal Housing Enterprise Oversight (OFHEO) on the first business days of March, June, September and December for the previous quarter. Housing Starts: The Census Bureau's monthly count of the number of private residential structures on which construction has started. Data for a particular month is released about two weeks into the following month. Data on permits issued is also released. The reported figure is generally a seasonally adjusted, annual rate.
Jumbo Mortgage Loan: A mortgage loan for an amount exceeding the Fannie Mae and Freddie Mac loan limit. In 2001, a residential mortgage loan over $275,000 is considered a jumbo loan. Because the two agencies can't purchase the loan from the lender, jumbo loans carry higher interest rates, generally about a quarter of a percentage point.
Loan-to-value Ratio (LTV): In a mortgage loan, the amount borrowed relative to the value of the property. An LTV of 80% means that the mortgage loan is for 80% of the value of the property, with the borrower making a 20% downpayment. Mean Home Price (of New or Existing Homes Sold): The mathematical average of the prices of all homes sold in the period. The mean price of homes sold generally runs higher than the median price due to the number of very high-priced homes. The National Association of REALTORS? usually releases home price figures for existing homes sold on the 25th of the month for the previous month; corresponding figures for new homes are released a few days later by the Bureau of Census.
Median Home Price (of New or Existing Homes Sold): Of all the homes sold during the particular period, precisely half sold for more than the median price, and half sold for less. When determining the median, only one home price matters - that of the home in the middle. Because homes sold for exceedingly low or high values only count as one unit when determining the median - i.e., their values don't matter - median home prices are generally a better indicator of home price trends than mean, or average, home prices (where all the values matter). The National Association of REALTORS? usually releases home price figures for existing homes sold on the 25th of the month for the previous month; corresponding figures for new homes are released a few days later by the U.S. Census Bureau.
Mortgage Application Index: Purchase: An index published weekly by the Mortgage Bankers Association of America which gauges the number of applications submitted for the purchase of a home. The survey covers about 40% of all retail residential mortgage transactions and is released every Wednesday for the week ending the previous Friday.
Mortgage Application Index: Refinance: An index published weekly by the Mortgage Bankers Association of America which gauges the number of applications submitted for the refinancing of a home. The survey covers about 40% of all retail residential mortgage transactions and is released every Wednesday for the week ending the previous Friday.
New Home Sales: The Census Bureau surveys builders nationwide and bases their figure on the number of contracts signed for new homes. Because it reflects contracts rather than closings (as is the case with existing home sales), new homes sold should more quickly reflect changes in mortgage rates and the economic environment. The reported figure is generally a seasonally adjusted, annual rate.
Producer Price Index (PPI): A measurement of the average change in the selling prices of goods and services sold by domestic producers, and therefore an indicator of inflation. The most quoted PPI figure is the change in the prices of finished goods, that is, goods that are ready for sale to the final user (either households, businesses or governments). The so-called "core PPI" reflects the changes in price of finished goods excluding food and energy. The finished-good PPI and the Consumer Price Index differ due to the latter's inclusion of distribution costs, sales taxes, and government subsidies, as well as the types of products covered. The PPI is released by the Bureau of Labor Statistics in mid-month for the previous month.
Productivity: The measure of output per hour, and one of the most critical indicators of an economy's long-term health. Unfortunately, it's also very tricky to measure, especially in the services industries. Growth in productivity allows wages to rise while prices remain stable. The Bureau of Labor Statistics publishes quarterly productivity figures eight times a year (including revisions).
Securitization: The pooling of mortgage loans into a mortgage-backed security. The principal and interest payments from the individual mortgages are paid out to the holders of the MBS security.
Underwriting: The determination of the risk a lender would assume if a particular mortgage loan application is approved. Ability and willingness to abide by the mortgage loan terms, as well as the value of the property involved, are critical to the underwriting analysis.
Unemployment Rate: The percentage of the labor force out of work. To be considered a member of the labor force, an individual must either be employed or actively looking for employment (so those without jobs who are not looking for work are not, technically, unemployed). Released by the Bureau of Labor Statistics on the first Friday of the month for the previous month.
Find out when and how to act
Step 1: Decisions, Decisions
The decision to refinance depends on many variables. How long have you owned the home? How long do you expect to continue to hold an ownership position? Has your ability to qualify for financing changed since you took out your original loan? Do the savings justify the cost or the hassle? Will you incur a penalty if you pay off your current loan too soon?
Why Refinance?
Most people refinance to lower their monthly mortgage payments. If rates have come down significantly since you obtained your original loan, you may be able to cut your payments substantially. But there are other reasons to turn in your old loan, too.
Perhaps you want to reach into the equity that's built up in your home since you bought it. In that case, you can do a "cash-out refi" by taking out a new mortgage based on the home's current worth, pay off what you still owe on the old loan and pocket the difference.
Or maybe you want to shorten the period you'll be making payments. You can do that by swapping your current 30-year mortgage for a 15-year loan or one of practically any other duration. If rates have come down enough, you may even be able to achieve this with little or no increase in your monthly outlay.
Another reason to refinance might be to jump from an adjustable-rate mortgage (ARM) - where your rate changes with market conditions - to a fixed-rate loan which offers the certainty of set payment amounts no matter what happens to mortgage rates in the future. Or, since ARMs often start off at rates substantially lower than those charged for fixed loans, you might want to go the other way and take advantage of a particularly low introductory ARM rate. You might even want to switch from an ARM which is about to be more costly (the rate's going up) to another ARM with a lower starting rate. Your options are practically endless.
When to Refinance
At one time, the general rule of thumb was that it paid to refinance only when the current rate is two percentage points lower than what you are currently paying. But with the advent of "no- cost" refinancing options, that precept is no longer valid. However, the term "no-cost" is something of a misnomer. It doesn't mean free; it means you won't have to pay anything out of your own pocket at the time of closing. Either the fees charged by the lender will be rolled into your new loan balance or the rate will be somewhat higher than you could obtain if you paid the lender's charges up-front.
Still, the real determinant is how long it will take to recoup your costs. One idea is to weigh monthly savings against up-front costs. If you can save $100 a month on your mortgage payment by refinancing, but you have to pay $2,500 for the privilege, then you have to keep the new loan for at least 25 months to make up the difference. If you're planning to move sooner, it doesn't pay to refinance. But if you are going to stay in the house longer, refinancing is usually a sound financial decision.
When Not to Refinance
The missing link in all of this is how long you've held your current mortgage. Because you will be starting all over again with a brand new mortgage, the longer you have had your present loan, the less advantageous it is to refinance, especially if the difference between your old and new interest rate isn't significant.
Consider someone who wants to trade in a four-year-old loan on which he has already paid $25,000 in interest. By starting over, he could be paying more in interest for both loans than if he had stuck with the old one, depending on the difference in rates. You should do the math before making a final decision.
Remember, your house payments in the early years of your loan are almost all interest. Popular wisdom has it that interest isn't so bad because it's deductible. But interest isn't all it's cracked up to be. For one thing, interest is cash out of pocket - your pocket. Yes, every dollar you pay in interest is deductible on your tax return, but your tax savings is only equivalent to your tax bracket. So if you are in, say, the 31 percent bracket, your net write-off is just 31 cents, not a full $1.
The only sound way around this problem is to switch to a loan with a shorter term, say 15 years rather than 30. Your monthly savings may not be significant, but you'll be shaving years off your loan, so your total interest costs won't be as great.
Another potential roadblock: A prepayment penalty clause in your current mortgage.
Many lenders now charge borrowers a penalty if they pay off their loans before a certain period. Usually, that's no more than two years, but sometimes it's five. The fee, which might be as much as a percentage of the unpaid balance or as little as a full month's interest, protects lenders against losing loans before they become profitable. In exchange, the borrower usually gets a slight break on his or her interest rate. But if rates fall during the penalty phase of the loan, the charge is one more cost you have to absorb.
Prepayment penalties are illegal in mortgages insured or guaranteed by the federal government and some other loans. Your loan documents will tell you whether your mortgage contains such a clause as well as the length of the penalty period and the fee.
How Much Will it Cost?
Since refinancing means you are taking on an entirely new loan, figure on spending roughly as much as you did to close your original mortgage. You're likely to be charged an application fee, points, a loan origination fee, a title search fee, a title insurance binder, an appraisal fee and other miscellaneous costs.
But what you actually pay is usually up to you and your ability to sniff out and bargain for the best possible deal. Generally, you can obtain the lowest possible rate on your new loan by paying all the loan costs yourself. But you may be able to get some of the fees waived if you return to your original lender. At the same time, though, other lenders might be willing to omit some charges to get your business.
It's also possible to finance your closing costs as part of the amount you are borrowing or eliminate them altogether by agreeing to pay a somewhat higher interest rate.
Step 2: Getting Ready
Since refinancing means you're starting the loan process again, you'll have to go through essentially the same process you did when you took out your current mortgage. First, you'll have to get all your records together and make sure your credit profile is in good order.
That said, you have an advantage with refinancing if you have a good payment history with your current loan. Lenders can see that you're a good risk, and that makes the qualifying process easier.
Paperwork
Nothing's changed: Your lender will need to verify your income, employment, account balances and the like, so be prepared. The lender will tell you exactly what you need, but generally you'll be required to produce current pay stubs and savings and checking-account statements. If you are self-employed, you'll also be asked to produce copies of your last two federal income tax returns as well as a profit-and-loss statement and perhaps even a personal financial statement. Also bring along a couple of blank checks to pay for a new appraisal and a credit report.
Polish Your Credit
Even if you are just thinking about refinancing, order copies of your credit reports from the three credit repositories - Equifax, Trans Union and Experian - and go over them to make sure they are accurate and current. If they're not, take the steps necessary to have the errors corrected and the information brought up-to-date.
Also, do what you can to make yourself more credit worthy. That includes scrapping those credit cards you don't really need, paying your account balances down to at least half of your maximum credit allowances, and making sure you pay all your bills on time.
Step 3: Loan Choices
Your choices now are probably just as wide as when you obtained your original loan, possibly even more so. There are fixed-rate loans of 15 and 30 years. There are adjustable-rate mortgages with varying adjustment periods. There are government loans - Federal Housing Administration (FHA) and Veterans Administration (VA) - conventional loans and jumbo loans (loans for more money than the conventional loan limit). There are loans which require private mortgage insurance (PMI) and combination first and second mortgages which eliminate the need for PMI.
What Type of Loan?
Most people favor fixed-rate loans because they like the idea of knowing exactly how much they will pay every month and that the amount won't ever change. Most people also realize that fixed loans last for 30 or 15 years. But actually, a fixed loan can be of any duration, so it's possible to switch to one that is of exactly the same term as what's left on the loan you are giving up. Realize, however, that even though rates on shorter-term loans are somewhat lower, the payments are usually higher because of the shorter payback period.
Adjustable-rate mortgages also come with 30- and 15-year terms. But more importantly, they come with a wide variety of adjustment periods. Some adjust once a year, but others have the potential to change as infrequently as every three, five, seven or even 10 years. ARMs with the shortest adjustment period come with the lowest rates, but even those that won't change for the first decade are somewhat less expensive than fixed-rate loans. The advantage of a short time frame is the lowest possible rate; the benefit of the longer one is the ability to lock-in a slightly lower rate and gain a wider window of opportunity to refinance.
If your downpayment is less than 20 percent, you'll be required to pay for private mortgage insurance that protects the lender in case you default on the loan. Consequently, to avoid PMI -- which can cost $100 or more a month, depending on a number of variables -- you can borrow no more than 80 percent of your home's current value. If necessary, you can take out up to 10 percent more of your equity with a second mortgage, and use the 10 percent equity in your home instead of a big downpayment.
Which Lender?
Start with your current mortgage company. Because of the high cost of originating home loans, most mortgages aren't profitable until they've been on the books for a few years. Consequently, some lenders will go to extraordinary lengths to keep their customers from going elsewhere. They may be willing to wave some or even all of your fees, especially if you've proven yourself to be a quality borrower by making all your payments on time.
If you are looking elsewhere, consider your local savings & loan or community bank; a local, regional or national mortgage company; or even a commercial bank. Practically everyone these days is in the home loan field, even credit unions.
You can hunt for the lowest rates on the World Wide Web, in your local newspaper or a financial magazine. Or you can hire a "mortgage broker" to look for you. Mortgage brokers don't fund loans. Rather, they handle the paperwork for finding lenders. Most brokers don't scour the entire market, either. But they usually do business with enough lenders to locate the best deals available on any given day.
The lowest rate is only part of the equation, however. Service also is important. Dealing with a lender who quotes the lowest rate doesn't do you any good if he or she can't deliver. To find a lender who's fast, honest and reliable, ask a few local real estate agents. They know who produces and who doesn't; their livelihoods depend on it.
How to Compare Loans
First, look at the APR, or annual percentage rate. This is the total charge for credit calculated on an annual basis and stated as a percentage. It includes not only your interest rate but also such one-time loan fees as discount points that increase your overall costs.
Lenders are required by law to provide this calculation to borrowers within three days after applying for a mortgage. This is one way to compare the cost of one mortgage against that of another. But there is a drawback: The figure assumes you'll hold the loan for the full term. If you pay off the loan any sooner - and most people move or refinance within seven to 12 years - your actual APR will be higher.
Because not all of the lender's charges are included in the APR, you also might want to ask the lenders you are considering to provide a list of all their closing and settlement fees and compare them on a side-by-side basis. Amounts not only vary, so do the charges themselves.
Finally, if you are considering an adjustable mortgage, lay out a worst-case scenario. Most ARMs come with annual and lifetime ceilings on increases in either the interest rate or the monthly payment to protect borrowers against what's known as "payment shock." But you still want to do the math to make sure you can handle the possibility that your loan could adjust to the maximum as quickly as legally permissible.