Refinancing Mortgage Often Smart - Even if You Have to Pay

Many homeowners are looking into refinancing as mortgage rates have fallen to record lows.

At the height of the housing boom, refinancing was doubly rewarding: You could lower your monthly payment and extract some cash to spiff up the kitchen.
With mortgage rates at record lows, refinancing still offers the promise of lower monthly payments. But forget about that Sub-Zero refrigerator. Instead of taking cash out, you may have to pay cash upfront when you refinance.

Here's why: If the loan-to-value ratio of your new loan is above 80%, a lender will probably require you to pay private mortgage insurance, which could wipe out the benefits of reducing your interest rate. You may also be ineligible for the lowest rates.

Suppose, for example, that you bought a home several years ago, when fixed mortgage rates were 6%. You paid $200,000 and put $10,000 down. You currently owe $180,000, but your home's value has declined to $160,000. To refinance to a lower rate and avoid private mortgage insurance, you'd probably need to put in $25,000 to $30,000, says Bob Walters, chief economist for Quicken Loans.

"You're going to pony up what is probably the equivalent of another down payment," says Keith Gumbinger, vice president of HSH.com, a mortgage publishing firm.

In the first quarter, 18% of borrowers who refinanced paid cash as part of the deal, according to Freddie Mac. Cash-out borrowers represented 28% of refinanced loans. Over the last two quarters, the percentage of cash-out refinanced loans hit the lowest level since Freddie Mac started analyzing the loans in 1985.

As long as rates remain at record lows, the trend toward cash-in refinances will likely continue, says Frank Nothaft, chief economist for Freddie Mac. Freddie Mac will release figures for the second quarter on Wednesday.

A good investment?

Interest in cash-in refinancings isn't limited to homeowners with unfavorable loan-to-value ratios, says Anthony Hsieh, chief executive of LoanDepot, an online mortgage lender. Most of LoanDepot's cash-in borrowers have plenty of equity, and are primarily interested in accelerating the payoff of their loans, he says. Many are shortening their 30-year loans to 20, 15 or 10 years, he says.

Often, these are people who didn't lose their jobs or homes during the downturn, and still have good credit scores, Hsieh says. They have some extra money, but don't trust the stock market, and are tired of earning abysmal rates on low-risk investments.

"You have consumer psychology coming out of a very challenging recession, low (mortgage) rates, and a lack of options for putting your money to work," he says. "All of that together created a perfect situation where cash-in really makes sense."

But before you write a check to a lender, sit down with a calculator and figure out whether the savings from a cash-in refinancing are worth the cost. What you need to consider:

•How long you plan to be in your home. With a conventional refinancing, borrowers often recover their upfront costs in a few months. But with a cash-in refinancing, it could take you much longer to get your money back, Gumbinger says.

Most borrowers will need to stay in their homes for at least five years before the investment starts to pay off, he says.

•Where you'll get the money. If you have money in a bank account earning 1% or less, you could earn a better return by buying down your mortgage rate, Walters says. Suppose you have a 6% rate on a $200,000 mortgage and pay $20,000 to lower it to 4.75%. You'll save $2,300 a year, which is a much better return than you'll get from your bank, Walters says. "If you have the means, the math makes a lot of sense."

But having the means to pay down your mortgage is key. You shouldn't deplete your emergency fund to lower your mortgage principal, Hsieh says. Lenders are much more reluctant to approve cash-out refinanced loans than they were a few years ago, so you may not be able to get that money back out if you need it, he says.

And while your home may look like a safer place to invest than the stock market, buying down your mortgage isn't risk-free, Gumbinger says. If the value of your home declines and you have to sell, the amount you spent to buy down your mortgage could disappear.

"Are you going to be there long enough at the very least to get your money back?" he says. "That's your primary consideration."


By Richard M. Hackett for USA TODAY