During the mortgage boom, Teresa Aiello was a typical home refinancer. After getting her initial mortgage, she refinanced in 2005, and then got a second mortgage in 2006.
The multiple mortgages were common, as was the result: Aiello owes more than her house is worth. Her second mortgage has a 10-percent interest rate. She’s only paying the interest now, but in nine years she’ll have to start paying off the principal, too.
Now Aiello faces a number of hard decisions.
“I’m struggling to afford my bills,” Aiello writes in response to a Credit.com story. “Do you think that I qualify to modify these loans? Do you think short sale will be a solution? Or going to bankruptcy?”
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After years of refinancing to take on more debt, like Aiello, now consumers may be refinancing their homes multiple times to reduce their debt. After years of near-record-low mortgage interest rates, some people who have already refinanced their mortgages are finding that it makes sense to do it again.
“I call it serial refinancing, and yes, I think it’s happening again,” says Keith Gumbinger, vice president of HSH.com, a financial analytics company. “For some people, it makes a lot of sense.
During the mortgage boom, most people who repeatedly refinanced their homes were trying to get out of mortgages in which the interest rates fluctuated. Some people started out with a few years’ of super-low “teaser” interest rates before resetting; other people had rates that fluctuated regularly.
To avoid higher payments and the instability of fluctuating rates, many consumers refinanced. And as they built up more equity or their credit scores improved, some refinanced again for even lower rates.
“This happened a lot during the boom,” says Barry Paperno, Credit.com’s credit scoring expert.
This time around the mechanism is similar, but the economic conditions are much different. Interest rates fell steadily after the 2008 mortgage bust, and for the last few years people with the best credit scores could qualify for rates just over 3.5 percent, a 60-year low, Gumbinger says.
That has set off a chain reaction. Some borrowers with excellent credit were able to refinance their pre-bust mortgages to post-bust rates of around 6 percent, says Gumbinger. As interest rates continued to drop, some were able to refinance again, locking in super-low rates.
Now, a few homeowners may even be going for their third refinance. They already have have record-low rates, but now they might also be able to shorten the total mortgage term from 30 years to 15, Gumbinger says, saving them a lot of money in interest over the life of the loan in exchange for only slightly higher monthly payments.
“If you’re going from a 30-year term to a 15-year term, that could be great,” says Gerri Detweiler, Credit.com’s consumer credit expert. “With a lower interest rate, you could actually afford a 15-year loan and pay it off much faster, and pay a lot less in interest over time.”
Data to support this emerging trend is hard to come by, Gumbinger says. Serial refinancers aren’t tracked by themselves, which means their second and third loans are buried inside the larger total numbers of new mortgages, which actually decrease by a slight 2.5 percent in the most recent totals compiled by the Mortgage Bankers Association.
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Instead, most of the evidence for this new version of refinancing is anecdotal, Gumbinger says. “I’ve seen it, I just haven’t seen any statistics,” he says. “But it stands to reason. Once you have interest rates that stay this low for this many quarters, some people are going to take advantage of that.”
Should one of those people be you? Just because a lender offers you a mortgage refinance doesn’t mean you should take it. A refinanced loan doesn’t make sense for everybody. Here are three tips if you’re considering your first mortgage refinance — or your second or third.
The Interest Rate Break. A refinanced loan counts as a new mortgage, which means you will have to pay over $1,000 in new loan fees every time you do it. Sometimes those fees are paid upfront, and other times they are wrapped into your monthly payments.
Either way, you have to make sure that the interest rate reduction saves you more money than you will pay out in new fees. Gumbinger suggests that a 1-percent interest rate drop is more than enough. This guide from Credit.com suggests that actually you should make sure to drop the interest rate by 2 percent. Do the math for yourself, considering your income, the equity you have in the house, and your monthly payments to see if a refinance makes sense for you.
For help, check out this refinancing calculator.
The Bigger the Mortgage, the More You Save. In refinancing, the spoils go to the people who had more money to start with. If you have a large loan and large monthly payments, even a small interest rate drop could save you lots of money every month, and over the life of the loan. Someone with a $500,000 mortgage could easily save $200 a month by refinancing, Gumbinger says.
For people with smaller mortgages, they’ll need a bigger interest rate cut to make a refinance pay off.
“Larger mortgages have larger breaks if you refinance,” Gumbinger says.
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Consider the Immediate Impact. In the short-term, any application for new credit causes a small dip in your credit score, Paperno says. If you’re refinancing to give you some breathing room so you can afford a home remodeling project, for example, a small credit score drop on your home could leave you paying a lot more in interest on a new pickup truck, say, or tools and materials for the job.
Image: David Sawyer, via Flickr