Mortgage strategies

Mortgage strategies

Refinancing your mortgage

Finally you may be wondering when you should refinance your mortgage. If you have a high-interest mortgage and rates have fallen, you should think about refinancing.

But refinancing costs money, so it depends on how long you plan to stay in the home. As a general rule, if current rates are two percent below your rate, and you plan on staying in the home for at least three more years, you should come out ahead by refinancing.

Mortgages and points (pre-paid interest)

But when you refinance, how should you do it? Or for that matter, when you take out a new mortgage, what kind should you get?

When you refinance your mortgage, you may be able to go for a 15 or 20 year mortgage without raising your monthly payments. But when you refinance, you probably should avoid paying too many points.

Points are prepaid interest, so there's a trade-off between higher points and a lower ongoing interest rate. Suppose you're borrowing $100,000. You could pay two points, or $2,000 in up-front interest, and pay 8.5 percent on $100,000 for the life of the mortgage.

Or you could pay one point, or $1,000, and pay the higher rate of 8.75 percent for the life of the mortgage.

Whether you pay more up-front points or not depends on how long you plan to keep the mortgage. If you plan on moving in a short time, say three years, it's probably better to take the higher ongoing rate and minimize your cost in points.

The situation changes a little if you refinance. If you're taking out a mortgage for a new home, all of the prepaid points are tax deductible in the year you take out the loan.

However, when you refinance, points you pay on the refinancing aren't immediately deductible. The cost of the points must be amortized or spread out over the life of the mortgage. So generally, you want to pay fewer points when you refinance.

What type of mortgage to get

But what type of mortgage should you look for? Back in the 1960s a 30-year, fixed-rate mortgage from your local savings and loan was about the only game in town. With the rise in housing prices and interest rates in the 1970s, however, all kinds of new mortgages like adjustable rate or balloon mortgages cropped up.

Although these kinds of mortgages were useful in the early 1980s when interest rates were high and volatile, they're less useful now that we've entered an era with lower, less volatile rates.

So nowadays, if you have to get something other than a fixed rate mortgage with fixed monthly payments, you may be buying more home than you can afford. If you'll only be in the home for a few years, an adjustable rate mortgage might be all right, but you'll sleep easier with a fixed-rate mortgage.

Still there's been a lot of financial innovation in mortgages, and depending on your circumstances, you could do better with a nontraditional mortgage.

For example, let's say you know you're only going to live in a home for five years. In this case, you might be able to find a mortgage that offers a fixed rate for five years, and then changes to an adjustable rate for the remaining 25 years. This will give you a fixed rate while you're in the house, with a lower overall rate because of the floating rate after the first five years.

Mortgages will be one of the biggest expenses in your life, so it pays to shop around and look for every advantage you can find.