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The Prospective Homebuyer's Guide - Smart Home Ownership

Refinancing

If you were lucky enough to buy your home when mortgage rates were low, and you chose a fixed-rate loan, then you may have no need to refinance. But if you bought it when rates were higher, or if you have an adjustable-rate loan, then you may be a candidate for refinancing.

What is refinancing?

In a nutshell, you get a brand new loan and get rid of the old one.

Should you refinance?

This information will answer some questions that may help you decide. If you do refinance, the process will remind you of what you went through in obtaining the original mortgage. That's because, in reality, refinancing a mortgage is simply taking out a new mortgage. You will encounter many of the same procedures -- and the same types of costs -- the second time around.

Would refinancing be worth it?

Essentially that depends on how much money you're going to save over the long term, versus your up-front costs for making the change. A good rule of thumb is that if the interest rate on your current mortgage is at least two percentage points higher than the prevailing market rate, you're a good candidate for refinancing.

You also need to think about how long you plan to stay in the house. If, after all, you're going to leave in a year, then it's extremely unlikely that it will be worth it to refinance. Again, the general rule of thumb is that you need to be in the house for at least an additional three years in order recoup the cost of refinancing. Remember, though, that your particular loan amount and individual circumstances may make refinancing worthwhile for a shorter period of time, or at an interest rate that is less than 2 percent below your current loan.

Are there additional reasons to refinance?

In addition to the obvious reason of flat-out saving money, you might want to refinance for other reasons. For instance, you might want to build up equity in the home more quickly (by converting to a loan with a shorter term) in order to have that money available down the road for a big-ticket purchase, or for children's education. You may have an adjustable-rate mortgage (ARM) and find that you're uncomfortable not knowing exactly what the payments will be -- so you'd like to switch to a fixed-rate mortgage.

Alternatively, you might want to stick with an ARM, but you may have found one with a lower interest rate, or with appealing features such as payment caps that are not in your current loan.

If you do refinance your ARM, it will be because the next interest rate adjustment on your ARM will increase your monthly payments. Again, if you can save two to three percentage points (because current ARMs are being offered at lower rates) then it may well be worth your while.

If you choose not to refinance, you might still ask your current lender whether it is possible to modify your current loan in order to have it better serve your needs.

What are the costs of refinancing?

Since costs may vary widely -- depending on the price of your house, your geographical location, and the lender you've chosen -- use the following are estimates. Some fees may be waived in certain situations -- just be sure that you've asked all the questions up front, so that you know all the costs going in. 

  • Appraisal Fee: $150 to $400 
  • Title Search and Title Insurance: $450 to $600 
  • Mortgage Insurance: 0.5 percent to 1 percent (could be needed, depending on how much equity you have in the home) 
  • Points: 1 percent to 3 percent (Remember that points are nothing more than pre-paid interest, so you should only be paying points if the lender will discount the interest rate.) 
  • Prepayment Penalty: This could become the greatest single deterrent to refinancing. If it is large enough, this penalty could offset the savings you gain by refinancing in the first place. Prepayment penalties are forbidden on certain loans such as FHA and VA loans. Your current mortgage documents will indicate whether or not there is a penalty for prepayment. If there's any question, of course, ask the lender for clarification.

A general rule of thumb is that you should plan on paying 3 percent to 6 percent of the outstanding principal in refinancing costs, plus any prepayment penalties. Your lender may be willing to waive some of these costs and requirements, especially if the work relating to the first mortgage closing is still current.

*Hot Tip: Military.com offers an easy application form to apply for refinancing! A loan consultant will get in touch with you to help complete your application.

Insurance

Insurance is a very competitive business, and the price you pay for your homeowner's insurance can vary enormously. Companies offer several types of discounts, but they don't all offer the same discount, or the same amount of discount in all states. So, to begin with, ask your agent or company representative about any discounts available to you.

Here are some things to consider when buying homeowner's insurance.

Shop around.

It'll take a few phone calls, but this could save you a good sum of money. Ask your friends, check the Yellow Pages, call your state insurance department. Also check consumer guides, insurance agents, and companies. This will give you an idea of price ranges and tell you which companies or agents have the lowest prices. From time to time, Consumer Reports ranks insurance companies according to responsiveness and customer satisfaction; check to see if there are recent ratings. Then, when you've narrowed the field to three insurers, get price quotes.

But just as man does not live by bread alone, you should not consider price alone.

The insurer you select should offer both a fair price and excellent service. Quality service may cost a bit more, but it provides added conveniences, so talk to a number of insurers to get a feel for the type of service they give. Ask them what they could do to lower your costs. Check the financial ratings of the companies, too.

Raise your deductible.

Deductibles are the amount of money you have to pay toward a loss before your insurance company starts to pay. Deductibles on homeowners' policies typically start at $250. By increasing your deductible to $500, you could save up to 12 percent ; $1,000, up to 24 percent; $2,500, up to 30 percent ; and $5,000, up to 37 percent , depending on your insurance company.

Buy your home and auto policies from the same insurer.

Some companies that sell homeowners', auto, and liability coverage will take 5 percent to 15 percent off your premium if you buy two or more policies from them.

When you buy a home.

Consider how much insuring it will cost. Because a new home's electrical, heating, and plumbing systems and overall structure are likely to be in better shape than those of an older house, insurers may offer you a discount of 8 percent  to 15 percent  if your house is new. Check its construction, too. Brick, because of its resistance to wind damage, is better in the East; frame, because of its resistance to earthquake damage, is better in the West. Choosing wisely could cut your premium by 5 percent  to 15 percent . Avoiding areas that are prone to floods can save you $400 or so a year for flood insurance. Homeowner's insurance does not cover flood-related damage. If you do buy a house in a flood-prone area, you'll have to buy a flood insurance policy, too. Does your town have full-time or volunteer fire service? And is your house close to a hydrant or fire station? The closer your house is to firefighters and their equipment, the lower your premium will be.

Insure your house, not the land.

The land under your house isn't at risk from theft, windstorm, fire, and the other perils covered in your homeowner's policy. So don't include its value in deciding how much homeowner's insurance to buy. If you do, you'll pay a higher premium than you should.

Beef up your home security.

You can usually get discounts of at least 5 percent  for a smoke detector, burglar alarm, or dead-bolt locks. Some companies offer to cut your premium by as much as 20 percent if you install a sophisticated sprinkler system and a fire and burglar alarm that rings at the police station or other monitoring facility. These systems aren't cheap and not every system qualifies for the discount. Before you buy such a system, find out what kind your insurer recommends and how much the device would cost and how much you'd save on premiums.

Stop smoking.

Smoking accounts for more than 23,000 residential fires a year. That's why some insurers offer to reduce premiums if all the residents in a house don't smoke.

Once you retire.

Retired people stay at home more and spot fires sooner than working people. Retired people have more time for maintaining their homes, too. If you're at least 55 years old and retired, you may qualify for a discount of up to 10 percent at some companies.

See if you can get group coverage.

Alumni and business associations often work out an insurance package with an insurance company, which includes a discount for association members. Ask your association's director if an insurer is offering a discount on homeowner?s insurance to you and your fellow graduates or colleagues.

Stay loyal to your insurer.

Sure, that sounds like "Be True To Your School," but there's a practical reason: If you've kept your coverage with a company for several years, you may receive special consideration. Several insurers will reduce their premiums by 5 percent if you stay with them for three to five years and by 10 percent if you remain a policyholder for six years or more.

Compare the limits in your policy and the value of your possessions at least once a year.

You want your policy to cover any major purchases or additions to your home. But you don't want to spend money for coverage you don't need. If your five-year-old fur coat is no longer worth the $20,000 you paid for it, you'll want to reduce your floater and pocket the difference.

If you're in a government plan.

If you live in a high-risk area -- one that is especially vulnerable to coastal storms, fires, or crime -- and have been buying your homeowner's insurance through a government plan, you should check with an insurance agent or company representative. You may find that there are steps you can take that would allow you to buy insurance at a lower price in the private market.

Home Equity

By using the equity in your home, you may qualify for a sizable amount of credit, available for use when and how you please, at an interest rate that is relatively low. Furthermore, under the tax law -- depending on your specific situation -- you may deduct the interest because the debt is secured by your home.

If you are in the market for credit, a home equity plan may be right for you. Before making this decision, you should weigh carefully the costs of a home equity line against the benefits. Shop for the credit terms that best meet your borrowing needs without posing undue financial risk. And, remember, failure to repay could mean the loss of your home.

There are actually two variations on this home equity theme: lines of credit and loans. First we'll look at a home equity line of credit, then at the costs involved, and finally at home equity loans.

What is a home equity line of credit?

A home equity line is a form of revolving credit in which your home serves as collateral. Because the home is likely to be a consumer's largest asset, many homeowners use their credit lines only for major items such as education, home improvements, or medical bills, and not for day-to-day expenses.

With a home equity line, you will be approved for a specific amount of credit -- your credit limit -- meaning the maximum amount you can borrow at any one time while you have the plan.

Many lenders set the credit limit on a home equity line by taking a percentage (say, 75 percent) of the appraised value of the home and subtracting the balance owed on the existing mortgage. For example:

Appraisal of home: $100,000
 Percentage of appraised value: $75,000 ($100,000 x 75 percent )
 Less mortgage debt of $40,000
 Potential credit line: $35,000

In determining your actual credit line, the lender also will consider your ability to repay, by looking at your income, debts, and other financial obligations, as well as your credit history.

Home equity plans often set a fixed time during which you can borrow money, such as 10 years. When this period is up, the plan may allow you to renew the credit line. But in a plan that does not allow renewals, you will not be able to borrow additional money once the time has expired. Some plans may call for payment in full of any outstanding balance. Others may permit you to repay over a fixed time, for example 10 years.

Once approved for the home equity plan, you will be able to borrow up to your credit limit whenever you want. Typically, you will be able to draw on your line by using special checks.

Under some plans, borrowers can use a credit card or other means to borrow money and make purchases using the line. However, there may be limitations on how you use the line. Some plans may require you to borrow a minimum amount each time you draw on the line (for example, $300) and to keep a minimum amount outstanding. Some lenders also may require that you take an initial advance when you first set up the line.

What should you look for when shopping for a plan?

If you decide to apply for a home equity line, look for the plan that best meets your particular needs. Look carefully at the credit agreement and examine the terms and conditions of various plans, including the annual percentage rate (APR) and the costs you'll pay to establish the plan. The disclosed APR will not reflect the closing costs and other fees and charges, so you'll need to compare these costs, as well as the APR's, among lenders.

Interest Rate Charges and Plan Features

Home equity plans typically involve variable interest rates rather than fixed rates. A variable rate must be based on a publicly available index (such as the prime rate published in some major daily newspapers or a U.S. Treasury bill rate); the interest rate will change, mirroring fluctuations in the index. To figure the interest rate that you will pay, most lenders add a margin, such as two  percentageage points, to the index value. Because the cost of borrowing is tied directly to the index rate, it is important to find out what index and margin each lender uses, how often the index changes, and how high it has risen in the past.

Sometimes lenders advertise a temporarily discounted rate for home equity lines -- a rate that is unusually low and often lasts only for an introductory period, such as six months.

Variable rate plans secured by a dwelling must have a ceiling (or cap) on how high your interest rate can climb over the life of the plan. Some variable rate plans limit how much your payment may increase and also how low your interest rate may fall if interest rates drop.

Some lenders may permit you to convert a variable rate to a fixed interest rate during the life of the plan, or to convert all or a portion of your line to a fixed-term installment loan.

Agreements generally will permit the lender to freeze or reduce your credit line under certain circumstances. For example, some variable rate plans may not allow you to get additional funds during any period the interest rate reaches the cap.

Homeownership and Taxes

As you've figured out, owning a home is an expensive proposition. Lucky for us, though, there's a silver lining to our little black cloud. What is it? Elementary, my dear Watson! It isn't a Sherlock Holmesian deduction. It's a tax deduction. And it's major.

When you file your federal and state income tax forms, you'll be able to deduct mortgage interest and property taxes (assuming that your loan is for $1 million or less). And there's even a deduction for up to $100,000 for a home equity loan.

So how much is this really going to save you? It works like this: Let's say that you're in the 28 percent tax bracket. Let's also say that, once you get your loan, you end up paying $1,000 a month. The interest portion of that $1,000 is tax-deductible -- and, in the early years of repaying the loan, almost all of it is interest. This means (assuming that you have other deductions at least equal to the standard deduction) that it will lower the amount of money on which you pay taxes. And this, of course, means that your tax bill will be significantly lower -- so you'll effectively end up having paid something like $720 a month for that loan. ($1,000 minus 28 percent , or $280.)

This is not to say that the reason to buy a house is to save taxes, but it sure is a nice perk. And the place you live will belong to you, not some landlord who doesn't know your name, won't fix plumbing problems, doesn't like you knocking holes in the wall to hang paintings, and threatens to call the police when you try to sneak a waterbed up the back stairway.

One caveat -- be sure to check with your accountant to make sure that you're going to be able to get the tax savings you expect. The likelihood is that you will, but you don't want to count on this kind of savings and then discover that for some reason you've miscalculated.

So go ahead, slosh away. If the waterbed springs a leak, it's your problem. Welcome to the joys of home ownership. You've just investigated the "ins and outs" of loans. Go forth and enjoy your new home!

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