Mortgage Refinance Options - No Cost vs Best Rates

by Scott from Tampa, Florida USA

Ask Kate about mortgage refinance options: No cost refi, the best mortgage rate with reduced loan term for quicker pay-off, or the lowest monthly payment? Scott's banker offered these 3 refinancing options. They are full of pros and cons and Scott admits to total confusion. Oh, one more thing! The no cost refi option includes ambiguous verbiage (gibberish) regarding the interest rate... and prepayment penalties.


Scott asks Kate about 3 Mortgage Refinance Options from His Banker

Hi Kate, I purchased a home back in October 2004 for $160,000.

Mortgage Refinance Options - No Cost Refi vs Best Mortgage Rates
The loan was done this way:

1. 80% ($128,000) - 30 year fixed at 6.375%.

2. 20% ($ 32,000) - 20 year interest-only ARM which every 6 months is 3.50% + LIBOR rate. First 10 years in interest-only and last 10 years is interest + principle.

Current status:

1. $111,000 left on 30 year fixed still at 6.375%.

2. $22,000 left on 20 year interest-only loan currently sitting at 4% (3.50% + 0.50 LIBOR rate).

3. Home is only worth probably $105,000. The 30 year fixed is eligible for HARP.

4. Nothing can be done with the interest-only loan.

Here are my options for refinancing the 1st mortgage:

Option 1. Refi to a 15 year fixed rate at approximately 3.375% + closing cost.

Option 2. Refi to a 30 year fixed rate at approximately 3.75% + closing cost.

Option 3. Refi to a 30 year fixed rate at approximately 3.85% + no closing cost (bank pays for it). However there is a line in the 3rd offer that says:
'If a refinanced mortgage has a longer term than remains on your current loan, you will incur additional interest charges for the extended term?'
What on earth does this mean? Also penalties for additional payment towards principle would apply.

I am trying to figure out the best route to go:

1. If I go the 15 year route, my principle + interest payment will roughly be the same as what I pay now which is $800 per month. Is it better to pay the lower interest rate + closing cost?

2. If I go the 30 year route, I will pay a lower monthly payment. The extra money I am saving I can use toward paying off the 20 year interest-only loan faster. Then once that is paid off, use the savings toward paying the 30 year fixed loan faster. Should the primary objective be to pay the 20 year interest-only off quicker if possible by taking a new 30 year refinance for the lower payment?

3. Is the 30 year refinance with bank paying the closing cost with the slightly higher interest rate (plus whatever it means in that sentence I quoted up above) the better deal?

Any help you can provide would be extremely helpful.

Sincerely,
Totally Confused Scott

Kate Answers: Mortgage Refinance Options - No Cost Refi vs Best Mortgage Rates

Ask Kate at Get-Your-Best-Mortgage-Rate.com
Dear Scott,

This is not as complicated as it may seem. One simple way to sort through options is to determine your goals.

But before we begin, I also need to point out that I am not a financial adviser. So run your options and preliminary decision past your CPA to be safe.

Note: The following links will lead you to more information on my website to help you further understand your options.

Best Mortgage Rate vs Lowest Mortgage Payment vs No Cost Refi

First ask yourself which is more important to your budget and long-term planning:
  • Option 1 Best Mortgage Rate: If you are planning for retirement, the 15 year fixed rate will give you a faster 1st mortgage pay-off.

  • Option 2 Lowest Mortgage Payment: But for current affordability, the 30 year fixed rate with lower 1st mortgage payment still gives you the possibility to pay off the 2nd mortgage faster but offers a safety net should the security of your job become shaky.

  • Option 3 No Cost Refi: If you can't (or don't want to) pay cash for mortgage closing costs, assuming you do not have enough equity to finance them, the no cost refi could be a better way to go. But over the long-term, the higher interest rate of a no cost refi will become more costly!
Read more about understanding mortgage closing costs and Good Faith Estimates here.

Be sure to ask your loan consultant about this gibberish... 'incur additional interest charges for the extended term'. Sounds to me if your new mortgage term exceeds 21 years, your interest rate could be higher than the initial quote, my pet peeve! You need this answered before you can make a decision! Read about Manny's problems with no cost refinancing here.

Beware of Prepayment Penalties

Be very cautious about accepting a prepayment penalty. When I originated mortgages, I saw homeowner after homeowner absolutely sure they were going to keep their new financing for the long-haul, only to call me up a couple of years later to refinance.

Refinancing a mortgage with a prepayment penalty is prohibitively expensive. Get the terms in writing before you lock your interest rate.

I should add that HARP refinances are not allowed to charge prepayment penalties. Read more about this here: Refinancing and HARP 2 Guidelines.

Good luck and best wishes,

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