06 June 2009 -  Jacksonville, Florida USA                                        

 

Part 2 - When Is Refinancing Make Sense To You?

 

Mortgage Interest Rates Comparison

When I first received the approved documents from the bank re our mortgage re-financing loan, I was really confused why one of the documents, the ‘Bank Mortgage Loan Approval Letter’ was showing an interest rate of 4.250% but the other attached document, which is the “Federal Truth-in-Lending Disclosures” was showing an Annual Percentage Rate (APR) 4.812e%

So I called the bank and ask the difference between the two rates. The mortgage specialist answered, “Ma'am, I know it’s confusing and I don’t want you to get confused even more so I’ll just explain this APR thing in a very simple lingo. By law, the Federal Government mandates every lender to disclose the APR because loans are often offered on different terms. But no worries…you guys got approved for 4.250% interest rate which as you can see was stated in the Bank Mortgage Loan Approval document.”

I was like, HUH? So why on earth do you have to disclose the APR rate if it doesn’t affect anything? She reiterated, “Like I just said, it is very confusing and I don’t want to confuse you even more. Believe me when I say that the 4.250% is really the actual rate we used to determine your monthly mortgage payment, the total interest to be paid and the total-pay-out of your loan.”

To tell you the truth, I was even more in doubt but I let her go anyway because she wasn’t rude or anything. In fact, she really sounded nice to me although I got the impression that she probably doesn’t really want to waste more time explaining to me in details because I may not understand the language anyway just because I speak with an accent? I don’t know... hate to be cynical but I can’t help it sometimes.

Needless to say, I did my work by spending all my free time looking for answers and finally figured out the difference between the two: Nominal Interest Rate vs. Annual Percentage Rate

She was right in saying that the nominal rate which is the 4.250% is really the actual rate being used to determine the monthly mortgage payment, the total interest to be paid and the total-pay-out of the loan.

The  Annual Percentage Rate (APR) takes into account when we, the borrower, roll back the closing costs (origination fee and discount points and etc.) into the new loan amount. So in essence, APR is definitely the rate we should use to compare loan’s interest rates side by side, you know like you are comparing apples to apples or which loan gives you a better deal.

For example: Assuming that your current mortgage loan was previously for $200,000 at 5.875% on a 30-year Fixed Conventional Term.

This means your mortgage monthly payment without escrow is $1,183 and presuming you have not missed any payment since March 1, 2005. No extra payment made. If I do the math here, as of June 1, 2009 you have already paid a total of $61,520 on Principal and Interest and by 02/01/2035 the loan is going to be paid-off completely.

Hence, as of June 1, 2009, your pay off loan balance is $187,958.

Now you are trying to refinance this current mortgage loan balance of $187,958 for lower interest rate but you get confused with the different quotes from the lenders.

Let’s take a look at these two different rates with different closing costs variables:

Option A - 30-Year VA Fixed Mortgage Loan
Interest Rate     VA Funding Fee      Points           Origination Fee                 APR    
    4.250%               3.30%              2.50%                1.00%                         4.812%

Option B - 30-Yr Conventional Fixed Mortgage Loan
Interest Rate     VA Funding Fee      Points           Origination Fee                APR    
    4.750%                 0.0%               1.750%                1.00%                      4.885%

Note: Veterans Administration (VA) Loan Mortgages are government loans guaranteed by the Department of Veterans Affairs for eligible Military Veterans only. 

Here’s a question to consider with regards to APR: Is it beneficial for you to pay more closing cost upfront to get a lower nominal interest rate or pay less closing cost but on a higher nominal interest rate?

Which do you think is a better deal? First, ask yourself this questions: How much will it cost me to refinance?  Do I have the money on hand to shell out for the closing cost expenses or just roll the closing cost expenses to the new loan amount?

Let's crunch the numbers and compare the two: Let's say you are rolling over the closing cost to the new loan amount.

If you refinance using option A, your *closing cost is more or less about $18,990 hence the new loan amount including the closing cost is going to be $205,739 and your monthly payment is $1,012 whereas if you refinance using the option B, your *closing cost is more or less about $10,448 hence your new loan amount is only going to be $198,127 but your monthly payment is $1,034.

*Closing cost includes these Lender, Government and Settlement Fees:
     Origination Fee
     Discount Points
     VA Funding Fee
     Appraisal Fee
     Credit Report
     Flood Determination Fee
     Settlement Fee
     Abs/Title Search
     Title Insurance
     Recording - Deed
     Tax Stamp - Deed
     Survey Fee
     Pest Inspect Fee
     Prepaid Interest
     Hazard Insurance Escrow
     County Property tax Escrow

Remember, in your current loan, your mortgage monthly payment is $1,183.

Therefore, if you take option A, your month savings which can be applied to extra payment per month is $170.97 whereas if you take option B, the monthly saving is only $149.56

In essence, if you decide not to refinance and just stay in your current mortgage, your $200,000 house would cost you a total of $425,904 at the end of the loan (Principal and Interest)

However, if you re-finance using option A, including the amount you’ve paid since March 1, 2005, you’ll end up spending a total of $381,719 whereas option B, costs you a total of $387,152.

This means, with VA loan at 4.250%, you’ll be saving yourself about $44,184 while the Conventional loan at 4.750% saved you $38,751.

Between option A and option B, the VA loan at 4.250% is better than Conventional loan at 4.750% because not only you'll be saving yourself an amount equal to $5,433 at the end of the term but you'll also be paying off your home 5 months in advance.

That’s if you plan to remain in your home for the term of the loan but that's in the long run.  How about consider the short term? The thing to really consider here is to  ask yourself this question: How long do I plan to stay in this house?  What if I decide to move somewhere and sell my house in say 5 years later? 

Do the math again and compare how much you are going to save/loss in a short or long run.

Remember:
With VA loan at 4.250% you need to keep your house for at least 9.3 years   just to recoup the re-financing closing cost expenses.
Formula: ($18,990 divided by 170.97 = 111 months) or (111 / 12 = 9.3 years)

With Conventional loan at 4.750% you need to keep your house for at least 5.8 years  just to recoup the re-financing closing cost expenses.
Formula: ($10,448 divided by 149.56 = 69.85 months) or (69.85 / 12 = 5.8 years)

Now, take a look at the total total savings if you decide to pay $100 extra every month to your mortgage payment.

                                  TOTAL PAYMENTS AT THE END OF YOUR LOAN
                                                                             With $100 Extra         
                                  Without  Extra Payment    Payment Per Month                  Savings

Current Loan at 5.875%      $ 425,904                     $ 393,579                           $32,325                
Last Payment Date                  02/01/2035                     10/01/2030                             5+ yrs

Refinanced VA at 4.250%      $ 381,719                     $ 366,047                          $15,672    
Last Payment Date                   02/01/2032                    05/01/2029                              3+ yrs

Refinanced CON at 4.750%   $ 387,152                     $ 368,365                          $18,787
 Last Payment Date                  07/01/2032                     07/01/2029                              3+ yrs

Bottom line is, the VA loan @4.250% is the way to go even if your new loan amount was $7,612 more than the Conventional loan and you are not only saving $2,318 in total payment at the end of the term but you also pay-off your loan seven months in advance. The only downside with VA loan is if you decide to sell the house in the next 5 yrs, then you are screwed.

Here you can download the the Microsoft Excel files with series of worksheets I painstakingly created modeled from the Vertex42 Financial calculator to compute and compare different interest rates and which one gives you a better deal: Refinance Calculator 1 and Refinance Calculator 2 with monthly Extra Payment of $100.

You can easily find out the APR rate here at Bankrate calculator but me being the visual person; I don’t rely on APR rate alone. I want to see the actual figures to see the difference so I always crunch numbers before I decide which rate is beneficial for me!!!

Hope you do the same too so you won't get ripped off by some of these predatory lenders!