Frequently Asked Questions
Does it ever make sense to refinance a loan that has a prepayment penalty?
S.M from San Francisco, CA writes:
My present loan was made two years ago, and because I had some credit problems at that time, I had to pay 8½%. My loan balance is now $300,000 and my loan has a prepayment penalty for the first three years. I believe my credit now qualifies me for a better loan, and I want to refinance to take advantage of today's low rates. Unfortunately, my prepayment penalty is $10,200, so I thought I would wait another year, and then refinance once the prepayment penalty period expires. A friend told me that might not be my wisest course of action. What do you think?
H.I.S. Loans Response: -
Your friend is probably correct. Let's look at the numbers:
From the information you gave me, your payments presently should be about $2,345 per month, and if you were to refinance your balance of $300,000 for 30 years at 6½%, your payments would be reduced to $1,896 per month, a savings of $449 per month.
Unfortunately, because of your prepayment penalty, you would have to refinance your balance plus the prepayment penalty, so the new loan would be for $310,200, and at 6 ½% for 30 years the payments would be $1,960 per month, still a tidy savings of $385 per month.
In your situation, it would probably not make any sense to wait a year for your prepayment penalty to expire, and here's why:
Mortgage interest rates today are very close to their historic lows, and whenever rates are very low, the probability that they will go higher is a lot stronger than the probability that they will go lower. Therefore, if you wait a year so you can get a payment of $1,896 instead of $1,960, and the rates go up by only 1%, your payments on $297,500 (approximately what your balance will be in a year) at 7 ½% would be $2,080 per month.
This would be $120 per month more than they would be if you refinanced today and allowed the full amount of your prepayment penalty to be refinanced into the new loan. In addition, of course if the rates were to go up more than just 1%, it would have proven even more costly to wait.
In other words, the pain of not locking in today's incredibly low rates is a lot more painful than refinancing now and absorbing the prepayment penalty into the new loan
Something extra to make the pain a little easier to bear: The prepayment penalty is entirely tax deductible, so you'll have to pay less at tax time, or get a bigger refund.
Is a 30-year fixed rate loan the best kind of loan you can get?
B.S. from West Hollywood, CA writes:
I am looking to refinance my mortgage and take out some cash, and I have a 30-year fixed rate loan, and I want to get another one. My friend says 30-year fixed rate loans sometimes are poor choices. I always thought they were the best kind of loan you could get. What do you think?
H.I.S. Loans Response: -
There is a very firm and specific answer to this question, and it is "It depends".
There is no right or wrong when it comes to what kind of loan is the best kind. "It depends" on the individual homeowner's circumstances.
Let's look at 30-year loans. Over ninety percent of all mortgages made in the United States today are 30-year loans. But, there are many kinds of 30-year loans. The differences are in the initial fixed rate period. The longer it is, the higher the interest rate. That is, a 30-year loan where the interest is fixed for the first two years, or the first five years, has a lower interest rate than a loan where the interest rate is fixed for the entire thirty years.
The national average for home ownership is a little more than five years. Therefore, a homeowner has to ask himself, or herself, "How long do I expect to keep my home?" "Will I outgrow it in a few years?", or "Will I need a larger one if we have kids?" or "Do we think we can afford a nicer one in another year or two?" or "We love our home, we're not moving, and we expect to live here forever".
Some other questions to ask are: "Can I afford to shorten the remaining term of my loan and pay it off sooner?" If so, strong consideration should be given to a 20-year loan, a 15- year loan or even a 10-year loan.
What about cash flow? "Is it more important to me to conserve the most amount of cash now, because there are other uses for it (investments, debt reduction, or just plain feeding the kids)?" If this is your focus now, the loan for you is probably a "deferred interest" loan (sometimes called a neg-am). Payments on these loans are as low as an incredibly low $333.25 per $100,000 borrowed.
Whether or not a 30-year fixed rate loan is the best loan depends on the individual circumstances of each individual homeowner. At Nationwide, you can discuss your individual circumstances with an experienced loan officer who can review various options with you, and get you the loan that is best for you, not "sort of best" for most people.