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Tom Kelly
Tom Kelly
The Real Estate Adviser

January 23, 1998

The lowest interest rates not always best

By TOM KELLY
The Real Estate Advisor

"Who has the lowest rate in town?" is the question many consumers ask when home mortgages hit the news. The answer is not always as simple as providing a phone number of a certain mortgage lender. "Lowest" is not always synonymous with "best," because loan fees, term, index, margin and your need for liquidity also are critical elements of the equation.

And, those extremely attractive rates you hear on the radio or see in the newspaper may not fit your particular situation. Many times, the best "closeable" interest rate --the one you can actually qualify for and then successfully proceed to "close," may contain a higher rate or may be an entirely different program than the one you initially targeted.

"Certain credit or income problems could keep a borrower from obtaining the best possible rate available," said Washington Mutual's Steve Wilde. "In many cases they can be resolved and any repair should be done before the customer actually applies for the loan."

The home-loan business centers around collateral (your home) and risk (your ability the repay). If your credit has always been poor and you have a difficult time hanging on to a job, the lender is going to view you as a greater risk than the customer with flawless credit and a 20 years of continual employment with the same company. Typically, the greater the risk, the greater the interest rate.

Small blemishes or adjustments in credit and income will not curtail the average person from securing a conventional mortgage. However, chronic abusers of credit who also miss monthly mortgage or rental payments often are tossed in to a "B, C or D" risk category that are subject to higher rates and fees.

Often, borrowers looking to refinance have a terrific track record, sufficient equity in their property and a steady job. The risk factor is not even an issue, but does it make sense --from the consumer's standpoint -- to even consider seeking a new loan?

According to Freddie Mac, one of the nation's top providers of mortgage money (the company buys loans from lenders) the national average interest rate for a 30-year, fixed-rate loan last week was 6.88 percent -- 6.52 for 15-year loans -- with an average loan fee of 1.5 percent of the loan amount. The last time home-loan money was this low occurred the week of Oct. 15, 1993, when the national average for 30-year fixed, rate loans was 6.83 percent, 6.33 for 15-year money.

The decision to "refi" depends on your immediate cash needs (medical expenses, tuition, car) and how long you anticipate living in your home. And, would the money saved through lower monthly payments be worth the anxiety and stress of going through the process?

Let's take a look at the numbers to see how much money would be saved. Because I'm a pay-it-off person, let's consider the 15-year term this time around.

The interest paid over the lifetime of a 15-year, $150,000 loan with an interest rate of 8.5 would be $115,879.68. The borrower would make 180 payments of $1,477.11 a month. Two years into the loan, the $150,000 balance would be down to $139,195, and the borrower would have paid $12,133.81 in interest.

Now let's refinance that $139,195 balance at 6.5 percent, adding in "minimal" fees of $1,605 so the package to be refinanced is $140,800. The interest paid on a 15-year, $140,800 loan at 6.5 percent would be $79,973.45, and the borrower would make 180 payments of $1,226.52 a month. Even if you added the first two years of interest paid on the old 8.5 loan ($12,133.81), refinancing would save the borrower $23,772.42, assuming both loans run full term.

Remember, to refinance a mortgage you have to go through closing a second time and pay for many of the same reports and fees again. You might be able to get a break on some of the costs depending on your lender and when you last refinanced.

Homeowners often resent the costs, especially if they simply want to reduce their interest rate. Paying for title insurance again is one of their biggest gripes. But a new title policy must be done each time a property is sold or refinanced, even if an identical search was done a few months ago.

This is to ensure that no new liens, such as home-equity loans, have been placed against the property.

From a financial point of view, paying off your home sooner with a higher monthly payment tends to limit other opportunities, especially if the market changes. But if paying off your home loan would make you saner than if you had not done it, then by all means do it. It would not be worth getting a few more percentage points on your money if it were invested elsewhere.

Are you thinking of refinancing to an adjustable-rate mortgage? Again, the question is: How long do you see yourself staying in the house? If it's for longer than four to five years, a fixed-rate loan is probably the better choice.

With some 30-year fixed-rate loans carrying an interest rate of 7 percent, why take on an ARM at 4.5 percent that could be adjusted to 6.5 percent next year?

You might be asking how the interest rates on long-term loans got so close to the interest rates on short-term loans. Each lender you ask could give you a different answer. But when the "yield curve" is flat (the difference between long-term and short-term rates is less than 3 percentage points), consumers overwhelmingly choose long-term, fixed rates.

If you are thinking about another refinancing, weigh all costs and rates carefully before deciding. Make sure you understand "no fee" programs and calculate how long it would take you to repay the refinance costs.



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