Refiancing Means a Free Month and Other Nonsense

Roger Schlesinger
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Posted: Jul 03, 2007 1:15 PM
Refiancing Means a Free Month and Other Nonsense

I have heard it a million times, if I have heard it once, that when you refinance you get to skip at least one month of payments or more. The reason people believe that is they don't know or can't understand that mortgage interest is paid in arrears and that rent is paid up front. So when they think they are skipping a month in payments they simply aren't.

If your loan closes on the 10th of the month you are charged with prepaid interest until the end of the month, 18, 20 or 21 days of interest (leap year would be 19 days for all who wish to keep the record straight). You will not make a payment on the first of the month as you have prepaid the interest up until the first of the month and that interest pays the preceding month's bill. When the next month comes the preceding months interest is then due. Which gets me into my next point. If your adjustable is changing at the first on the next month you will be paying the increased interest (if the adjustable increases in rate) all during the month preceding the increase. Therefore if you don't want to pay this higher rate then you need to refinance before the month preceding the increase. Why does this happen: because interest is paid after it is earned not before.

When refinancing a primary residence you will have a three day right of recession. It cannot be waived and you must wait until the three days are up before the loan is funded. On a second home it is rarely applied and on a rental or non owner occupied it is never applied.

Lenders are wary of people not having enough time to review their decision on their own home loan and will allow you, in most cases, to rescind after the three days as long as the loan hasn't funded. Again, this only applies on primary residences and once in a great while on second homes.

On an option arm the three other options, not the teaser or minimum rate, are generally too high so one should always make the decision on this particular loan on the teaser or minimum rate and what it will do to your financial situation. The teaser or minimum rate is generally a negatively amortizing rate as it usually doesn't pay the interest due on the loan each month. The difference between the interest that is scheduled and the teaser or minimum payment is added to the balance of the loan and interest is charged on this amount as well.

Those with the financial capability and self control can sometimes put this type of loan to work for themselves without building a negative balance, but those who fit this category are few and far between.

Free loans are only "free" if the rate doesn't increase to help the originator pay for the cost of the loan. There isn't anything free about a 6.25% 15 year loan if the borrower can get the same loan for 6.00% without points but paying the closing costs, or 5.75% paying a point and paying the closing costs. One simply has to run the amortization of the loan in each case and compare the total payments versus the one time closing costs and it becomes evident.

Using a $350,000 loan with the aforementioned interest rate and term and the results are as follows: The free loan 6.25% has total payments of $540,176, the no point loan has total payments of $531,629 + $3000 in closing costs and the one point loan has total payments of $523,157 plus the closing costs of $3000 and the point of $3500.

It is always better to check on what you hear just to make sure you heard it right, or they told it the way it should be told!

When you are purchasing a second home it seems that most brokers or bankers feel that there is suppose to be a certain distance between your primary home and your second home. It just isn't so. I once did a second home for a borrower whose first home was seven miles away. His first home was in Newport Beach, approximately seven miles from the beach. His second home was on Balboa Island, with a boat slip and a sail boat, where he went on weekends and many vacations to be able to sail his boat and relax from a stressful week. It made sense to me and also the lender and thus he was able to get a loan on his second home at second home rates. Common sense does prevail, at times.

Most people in this Country live on a budget, or attempt to because they don't have vast sums of money. Yet when they have an opportunity to build equity for themselves that can lead them to vast sums of money the majority always have an objection and an alternative method that will not work as well. If I didn't know better I would believe that the vast majority of people really do not want to make the sacrifice necessary to have "a better tomorrow".

When I suggest they refinance to a shorter amortization as a 15 year loan they say they prefer to take a 30 year and not be bound by the higher payment of the 15 year. They will make "additional payments" along the way and that will work for them.

First of all they start with a higher interest rate, 30 year loans have higher rates than 15 year loans, which gets them off on the "wrong foot". Then they can't quite find the right time to make the additional payments because things have a way of coming up. And then the plan is shot to hell and...

When I stumbled across shorter term amortizations it became fascinating to me. I couldn't wait to see how much of the balance was coming off each month and to this day I am still fascinated. It is so important to your financial well being to pay down your mortgage that you should embrace anything that will keep you going. I know nothing as important as this.