Devoted to understanding the basics and fundamentals of investing

Ÿ       I would be interested in your comments about whether or not refinancing is worth it? Does using the old 2% rule still work? The decision to refinance is dependant on the cost of refinancing and the savings the new rate offers.  Closing costs, appraisals, and other refinancing costs used to be fairly standard across lenders.  Using a 2% difference in rates gave a high degree of certainty that you would repay the refinancing costs in a reasonable amount of time, usually less than two or three years.  Today, refinancing costs are very competitive and significantly less than before.  For some lenders, it makes economic sense to refinance for as little as ½%.

Ÿ       Or is such a decision better made by analyzing how long you plan to continue owning the house and making the payments on a new loan?  Reducing my comments to a corporate finance rule, you should refinance anytime the net present value of the transaction is positive.  That is, when the present value of the savings in future payments exceeds the cost of refinancing, you should do it.  This formula would take into account your holding period as the NPV formula is dependent on the periods to be discounted.

Ÿ       How influenced should I be by being offered a low rate with high points? Add the points to the cost of refinancing; it is cash out of your pocket.  Compare the savings of the new “low rate” payments with the old “high rate” payments.  Discount the difference back to the present at the rate you are earning on your investments.  Subtract the out of pocket cost from the discounted savings.  If the answer is positive you should do it.

Ÿ       Fixed or variable? You should match your liability stream (mortgage payments) to your cash flow stream realized from your labor and assets.  Generally, your income stream is relatively fixed, or at least does not fluctuate with the changes in interest rates. So, you should lock in a fixed rate.  

Ÿ       How often are variable rate mortgages adjusted, and how high can they go? Generally, adjustable or variable rate mortgages have a one, three or five year period where the initial interest rate is fixed.  They then begin to float, or change with the prevailing interest rates.  Most now have a maximum amount that the interest rates can go up initially and in each period.  They often have a life time cap.  They usually adjust semi-annually.  If these conditions are not specifically mentioned, then the sky is the limit.

Ÿ       Do lenders sell the variable rate mortgage harder than they do the fixed rate cousin because it is a safer loan for them to make? Adjustable rate notes do fit the liability stream of a bank well.  They like them.  But most mortgages get sold off and are securitized, so banks don’t care what they sell as long as it “conforms” to the standards needed to sell.  The bank makes its money in origination fees and in servicing fees. Realtors on the other hand, like adjustable rate mortgages because the initial payments are often lower and enable more people to afford a mortgage.  They push them hard.  The idea of saving an extra two percent in interest is very seductive, especially when you have to fight for every eighth of a point on a fixed rate loan!  It is seductive, that’s why almost 90% of recent mortgages in California are adjustable rate loans.

Ÿ       What if, instead of lowering your payments on a refinancing, you increase the amount you borrow to fold in the payment of all your closing costs, and your payments stay the same?   If you aren’t saving any money, don’t do it.

Ÿ       What if I refinance my home to improve my cash flow and lower my interest rate? Why would you do it for any other reason? Oh, you mean to pay off credit card debt? I am generally opposed to this practice as it puts your home and family at risk.  But, sometimes it is better than the alternative which would cost you your home anyway.

Ÿ       What if I refinance to raise cash to live on or to buy another property (pyramid)? It has always seemed much easier for me to borrow money than it is for me to pay it back!  I do not favor investments that put your family at risk of being out on the street.  Find some other way to finance it.