Should you refinance your mortgage or modify your loans?
Are you one of the thousands of people trying to figure out what to do about your home loan?
The rates have been dropping in the mortgage market, so which is the best course of action? And once you decide on what you need to do…how do you proceed?
It can be a confusing topic, and most people have no idea how to make a decision. I’d like to walk you through the process so that you can make the best possible long-term financial decision.
Why would someone want to do a loan modification?
What do you need to know about them?
Are you wondering why you should modify your loan?
The best reason of all is to lower your rate. That means you spend less money over the term.
The first thing you should know about loan modification is they are rare. A lot of banks don’t even offer them. It’s literally on a bank by bank basis.
- Does your bank offer loan modification?
Your term will be the same and your payment will be adjusted as you step into the next month.
All you have to do is go into the bank that you work with (and who offers the loan modifications) and ask for the current rate and pay a small fee. By doing it this way, the loan modification will save you several thousands of dollars on refinancing.
If you were to refinance it would take your loan out to another 15 to 30-year term, and you would spend at least four times as much money as you did on a relatively simple modification.
My wife, Taylor and I recently did a loan modification on our house. We were able to take our rate down well over a point, or 1%. Modifying your loan costs less than a total refinance.
Our loan modification cost us approximately $1,000, plus we didn’t have the hassle of refinancing!
How much does it cost to refinance your mortgage?
You know how much the loan modification cost us, but how much would it have been to refinance the loan?
The answer to that question is complex. A lot depends on which state your house is in. There are some states that have very expensive titles–others are equivalent to sales tax.
For example, a house in the eastern states has 1% x (plus the county the house is in may tack on another 1% tax).
Let’s say someone in an eastern state has a $500,000 loan. The taxes are $10,000, plus the cost of the title insurance and appraisal. The person can refinance for approximately $15,000.
It’s a different story in the midwest, the cost of refinancing will be about a third of the cost.
It’s all about location, location, location!
Why would you choose to refinance your mortgage?
This is one of those unique life situations in which the factors involved and the answer are going to vastly different for every homeowner.
Some questions to ask yourself are:
- How long am I going to live in this house?
- How much money will a refinance save?
- How much will a refinance cost?
- Will I break even in 3.5 years?
What if it looks like you won’t break even until many years have passed? That’s when you are back to the question of how long you’ll live in the home.
- Are you only going to live there for a few more years?
- Do you think it will be your “forever” home?
The statistics show that most people in their “forever” home will eventually move again, so it’s not actually forever. That also means that you won’t break even if you move.
If I refinanced now, it would have cost me even more money, but I would have been locked into a killer rate.
However, when I did a loan modification, I was hedging my bets. I was able to lower my interest rate, then if the rates dropped even further, I could still refinance for a better deal (even if the $1,000 spent on the modification was wasted).
Here are some examples with the current rates as of the end of September 2019, and keep in mind that rates fluctuate day by day:
This is what rates look like for someone who has put 20% down compared to someone who is putting 0% down. In the last couple of weeks, the 15-year rates are running in the 3.125% to 3.375% range. The rates went up slightly after the recent Fed meeting.
Less than a year ago we were at approximately 5.125%, on a 30 year. I know that sounds horrible, but that’s not a historic normal rate seen in over 20+ years.
I’ll give you this as a real-world example if we had a half-million-dollar loan at 4.25%, the total interest on that loan, a 30-year loan was $385,000. If the same loan, same term, same everything except for the interest rate was 3.75%. The interest cost would be $333,000.
That makes it $50,000 less over the life of the loan. An example of what a half percent rate drop means was approximately $50,000 in total interest savings over the life of that 30-year loan.
The percentages over the loan life can mean a lot of money saved (or lost).
What is an amortization schedule, and why are you paying interest first?
The amortization schedule will show you how your debt is being reduced over time. It indicates the payment schedule with how much interest and principal is being paid.
You might be shocked it you saw how much interest you pay on a 30-year loan (over the lifetime of the loan). It may feel like you are in a shark tank because the interest is paid before the principal. At first, most of your money is going to interest, with a smaller percentage going to the principal.
However, in the 20 to 25 years that will flip and you are paying more toward the principal, and less toward interest.
You can even search the amortization schedule in Google to figure out what your payments will be. Play with the numbers to compare your savings between the 15-year and the 30-year loans.
I’ll illustrate what I’m talking about:
If you have a half-million-dollar loan at 3.75%. That means your payment would be about around $2,850.
Do you know how much is actually going to principle? You might want to sit down. Only $85 is going to your principal loan amount.
The rest of your house payment is only interest!
It would be nice for everyone if they could get a 15-year loan right now, with the interest rates so cheap.
Refinance, Escrow and Taxes…Oh My!
So you’re thinking about refinancing.
Then you actually refinance and see your settlement statement. There might be a couple of new concepts for you to absorb (sorry)!
Do you already have an escrow account?
No matter, you’ll need to start a new escrow account!
Fast Fact: An escrow account is mandatory if you have less than 20% equity.
However, if you have 20% or more equity, escrow is optional. There is a Fannie rule that states banks will charge .25% a point even if you have more than 20% equity but choose not to escrow.
As a novice people don’t understand what happens to your current escrow. They mistakenly think that it will be credited toward your payoff. Instead, you have to pay the money out of your pocket for the new escrow account. Even if that means borrowing the money.
Are you wondering about the money in your current escrow account?
Well, you’ll get that money after 30 days. It’s within their legal rights to hold it, but think about how much money is made when they hold thousands of escrow accounts for a month. That’s a lot of money!
Now that know you’ll have to come up with funds to start a new escrow account, what exactly does that encompass?
You start where you are, more specifically with the month you are in. We’ll use September, so how much do you have in the escrow account? How much do you have in there for your tax insurance?
Take the amount that you have in your account up to the current month, then add an additional month, and this will equate the amount of cash you’ll need for your new escrow account.
I know, it’s confusing and expensive.
You can always have the option to borrow the funds you need. You can roll in escrow, similar to how you roll in your closing costs. That means if you’re not able to pay the escrow money upfront (because you are waiting for a refund from your prior account), then you can borrow it from your lender by rolling it in.
Sometimes it pays to strategize.
We had a client who had a higher interest rate on their debt than what they could get with a mortgage. When they did their refinance, they wrapped the escrow into the mortgage.
When the old escrow was refunded, they paid it toward their consumer debt. The interest rate at 3.75%, was obviously lower than the 22% on the credit card.
Oh, and the refund on your escrow account? It’s similar to getting cash out. A great cash flow suggestion is to pay off one of your car loans. Then you can put the monthly car payment amount in your savings account.
What if you plan to be in the house under five years? How do you handle closing costs in that situation? Is it a good idea to wrap your closing costs in?
The answer will depend on your circumstances. If you took a quarter-point higher, the bank is going to refund some of the money. You can use that to pay off your closing costs.
This strategy works if you are going to be in the house for a short time. There’s no reason for you to extend a 30-year-mortgage and have in higher interest rate.
Negotiate or Not?
Are you refinancing or buying a new house?
When all things are equal, the lender can’t offer one buyer a better deal than the next person. That changes when somebody comes along with an offer from a competitor. The bank can start negotiations in order to be competitive.
The person who has a prior offer from a bank’s competitor will drop closing costs or offer you a better rate. The bank can’t randomly drop fees, these days. There is no favoritism toward someone you know.
The Consumer Financial Protection Bureau (CFPB) is in charge of overseeing what is happening in the financial realm these days.
The Refinance Process
What are the steps to refinance your mortgage?
- Fill out an online application
- Your credit will be pulled and reviewed
- You’ll get an itemized list of documents to provide
- Choose who you want to close your title insurance
- Who do you want to shop your insurance with (provide his name and number)
The itemized list is a standard set of documents if you are employed by someone else:
- Two months of bank statements/retirement accounts
- Your most recent pay stubs
- Provide two years of W2s
Are you self-employed? You’ll need these documents:
- Two years of tax returns
Have you recently closed on a house?
It’s a good idea to go back for business with the same title company. They might negotiate a lower fee on the closing costs.
What is Title Insurance?
There are two parts to title insurance.
- Lender’s title policy (protects the lender)
- Owner’s title policy (seller pays for the purchase)
In a closing transaction, the title policy will protect the lender and consumer, in the event that something interferes with the title, such as unpaid contractors or stray judgments.
You need title insurance when you are buying a house, but not during your refinance.
Where Should You Start?
The best place to start is with the modification.
You can ask your lender if they offer loan modifications. If they do, find out their process and fees.
The modification is the best place to start because it is easier than going through all the paperwork and hassle of a complete refinance, which includes the appraisal.
The modification process is also less expensive than when you refinance your mortgage.
It will save you a whole lot of money in the long run!
Did you refinance your mortgage or modify your loan?
Tell us about your experiences in the Physician Mortgage FB group!