Arguably, item four can help
create wealth by lowering
your monthly outlay, but
this item lends itself to a different discussion.
In recent years, many have experienced
the best of both worlds regarding consuming
and borrowing.
It's easy to think of numerous reasons
to borrow and spend. We're inundated
daily with messages to consume--and most
of us are pretty good at it.
Certainly there are times when borrowing
can't be avoided, such as when buying
a home. Be very careful when you think
of your home as a source of funds for
consumption, however.
If you find it
hard to get rid of your credit card debt
and think borrowing against your home
is a good idea--think again. You might
be better off calling a credit counselor
for budgeting assistance, instead of
calling a bank for a new first or second
mortgage. Credit card debt won't cost
you your home if you don't pay it back.
A mortgage will cost you your home if
you don't pay it back.
Pulling equity out of your home can provide
important benefits. Be careful. Don't risk
the security of your home on frivolous
spending.
The
best use for the extra cash is to
pay off any higher rate loans you
may have. Let's say that you are
carrying a $15,000 car loan at 10%
and making minimum payments on a
$10,000 credit card balance at 17%.
Your monthly payments on those debts
would total $680.
Then assume you
refinanced your mortgage, taking
out an additional $25,000 to pay
off your car and credit card loans.
Result: At 7.5%, your additional
monthly mortgage payment would total
only $175, so you would come out
$506 ahead ($681-$176=$506).
Of course,
all the extra cash doesn't have to
go for paying off debts. By changing
from an ARM to a fixed rate mortgage,
for example, you can prepare for
the long run should you decide to
stay in this home. Or you can for
example, increase your mortgage by
$35,000, from $105,000 to $140,000.
Then used $3,000 of the proceeds
to pay your refinancing costs and
another $17,000 to pay off a 10%
home equity loan, which has payments
of $250 a month. Then spend the remaining
$14,000 to build a garage or what
ever you want-- and you can do all
this for just another $19 a month.
Mortgage Refinance Costs
When you refinance your mortgage,
you usually pay off your original
mortgage and sign a new loan. With
a new loan, you again pay most
of the same costs you paid to get
your original mortgage.
These can
include settlement costs, discount
points, and other fees. You also
may be charged a penalty for paying
off your original loan early, although
some states prohibit this.
The
total expense for refinancing a
mortgage depends on the interest
rate, number of points, and other
costs required to obtain a loan.
To obtain the lowest rate offered,
most mortgage companies will charge
several points, and the total cost
can run between three and six percent
of the total amount you borrow.
So, for example, on a $100,000
mortgage, the company might charge
you between $3,000 and $6,000.
However, some companies may offer
zero points at a higher interest
rate, which may significantly reduce
your initial costs, although your
payments may be somewhat higher.
Typically rolling financing cost
into the interest rate will cost
you more should you stay in the
home for more than three years.
Alternative Mortgage Programs
If you are thinking about refinancing
your mortgage, you might want to
consider other types of mortgages.
For example, you might want to
look into a 15-year fixed rate
mortgage.
In this plan, your mortgage
payments are somewhat higher than
a longer-term loan, but you pay
substantially less interest over
the life of the loan and build
equity more quickly. (Of course,
this also means you have less interest
to deduct on your income tax return.)
You also might want to consider
refinancing if you have an adjustable
rate mortgage with high or no limits
on interest rate increases. You
might want to switch to a fixed
rate mortgage or to an adjustable
rate mortgage that limits changes
in the rate at each adjustment
date as well as over the life of
the loan.
If you decide to apply
for refinancing with a particular
mortgage company, and if you do
not want to let the interest rate "float"
until closing, get a written statement
to guarantee the interest rate and
the number of discount points that
you will pay at closing.
This binding
commitment or "lock in" ensures
that the mortgage company will not
raise these costs even if rates increase
before you settle on the new loan.
You also may consider requesting
an agreement where the interest rate
can decrease but not increase before
closing. If you cannot get the mortgage
company to put this information in
writing, you may wish to choose one
that will provide this important
information.
Most companies place
a limit on the length of time (say,
30 days) they will guarantee the
interest rate. You must sign the
loan during that time or lose the
benefit of that particular rate.
Because many people refinance their
mortgages when rates decline, there
may be a delay in processing the
papers. Therefore, you may want to
contact the company periodically
to check on the progress of your
loan approval and to see if additional
information is needed.
How to Build Equity Faster
Many borrowers use a refinance to
shorten the term of the mortgage.
And brace yourself, even at low
rates, a shorter term means a higher
monthly payment. The benefit is
that you'll build up equity faster
and pay far less in total interest
over the life of the loan. Consider
this example. Recently, you took
out a 15-year fixed rate loan at
6.75% to replace an 8.13% ARM with
a 30-year term.
Your monthly payment
jumped by $200, but now you will
own your own home outright by the
time you retire. In addition, the
total interest on the 15-year loan
will come to $95,447, vs. $222,234
on the remaining life of the ARM
-- and that assumes the adjustable
rate would have held steady at
its current 8.13%. "This is
forced savings."
If
you can't afford the payments on
a 15-year mortgage, your next best
means of building equity is to refinance
for less than 30 years. To do so,
ask your mortgage company to customize
your new loan's term to match the
years that are left on your old loan
-- if you are five years into a 30-year
mortgage, for example, ask for a
25-year loan.
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