There are a number of common myths or prescriptions as to how a homeowner should refinance his or her current loan. In some cases, these guidelines do apply, however in most circumstances, the guidelines suggested by these myths just don't make sense. In this section we will discuss three of the most common myths that have circulated through the media and the public in general.
There are many different avenues of making refinancing work for you:
The Two Percent Rule
Many times you will hear or read a "financial expert" give advice on how to handle your mortgage. The advice you will sometimes hear them give is that for a refinance to be worthwhile you should be reducing your interest rate at least 2%. In most cases this just does not make sense.
To determine whether this "rule" applies to you, you need to take some other factors into consideration. First, you could reduce the rate on your loan while accomplishing some other necessary goal, such as combining your first and second trust deeds, or paying off bills with the equity (see Do You Need to Refinance?) You may reduce the rate on your loan by say 1 ½%, reduce your interest expense and obtain the results of the other goal at the same time.
Secondly, if you are paying minimal or no costs for a loan, there is no reason not to reduce the rate by say 1%. If you are able to do this the 2% rule does not apply. To summarize, just because you are unable to reduce the rate by 2% do not put off refinancing for some other goal or purpose.
The No Cost Loan
In many newspapers and other media you will see ads for "no-cost" or "no points" loans. These offers seem too good to pass up. In many cases the best thing to do is to pass it up. Because many people equate "no-cost" with being "free" they think that they are getting a bargain or something for nothing when this is really not the case.
A "no-cost" loan is really a misnomer. There are always costs involved in doing a loan and these costs will be paid by you the consumer one way or another. When you do a "no-cost" loan the fees to do the loan (apprais al, credit report, etc.) are paid for by the lender. In return, the lender is charging you a higher interest rate to pay for these fees. So, in essence, you will be paying for these fees over the life of the loan. If the life of the loan is very short (less than two years) a "no-cost" loan is probably the way to go. However, if you are looking at the long term (longer than two years) a "no-cost" loan is not a very good idea. Let's explain why. Look at the following examples:
Interest Cost Over 7 Years
30 Year Fixed
$0 - No Points, No Fees
30 Year Fixed
$2800 (One Point + other costs)
At 6.875% you would have paid $2,800 to obtain a $150,000 loan. This may seem like a lot to pay for a loan but compare it to the "No Points, No-Cost" option after seven years. After seven years the difference between the interest paid on the two loans is $9188. That "savings" of $2800 actually cost the borrower $6388!
Of course, a "no-cost" loan does make sense in some circumstances however in most cases where a borrower is going to be staying in the home for an extended period of time the loan does not make sense.
In most cases your current lender cannot offer you a better deal than anyone else. There are a number of reasons for this:
Your lender must be able to pool your loan with other loans and sell that pool to another investor at some later date, therefore in order to "re-do" your loan loan he must "re-do" all of the paperwork that was in the file when you first closed the loan. This includes a new apprais al, title report, credit report, etc. In the days when banks and savings and loans were the dominant lenders in home loans a bank could just tear up the old note and re-write it, however in this day and age loans must be re-underwritten to make them salable to other institutions.
In many cases your lender does not even own your loan anymore. Your current lender may own the servicing on your loan they may not own the underlying loan itself. If they don't own the loan there is no reason for them to offer you a better deal.
Janus Mortgage Corporation is a mortgage broker licensed in the State of California, under the auspices of the California Bureau of Real Estate license number 02038085 and the National Mortgage License Registry NMLS Number 1690954, . All offers for loan programs are made for loans on California properties only.