WHY REFINANCE?

Dear Abby:  I think I need to see a specialist, but my doctor

insists he can handle my problem.  Can a general practitioner really perform a heart transplant right in his office?

 A.   Hard to say, but considering that all you're risking is the  $20 co-payment, there's no harm in giving him a shot at it.

OK, you already have a mortgage, so why refinance? The reasons are as long and as varied as the borrowers. There is no one totally encompassing reason or set of guidelines for refinancing. It depends on a person’s individual set of circumstances and needs. Here are some of the more common reasons why to refinance.  

Better Rate – 

You’ve paid the mortgage for two years. You’ve read my report , Credit Scores –

 What They Mean And How to Play The Game, and raised your credit score. You

 now qualify for a better rate. The example below illustrates the difference between two interest rates for 30 year fixed term mortgages. 

Monthly principle and interest payments are lower for the lower rate. Total interest paid during the life of the loan is also less (of course). Maybe rates have simply gone down and it’s time to take advantage of the the opportunity to refinance. GOT PMI?  Dump it at the same time.

Pay off HIGH INTEREST Non-deductible debt – (credit cards, car payments, home improvement loans,  etc..)

Credit card interest rates are typically around 20%. Some are more and some are less. At such high rates, it is hard to get out from under their thumb. Minimum payments are usually 3% on credit cards. There are no tax deductions for credit card debt. Mortgage interest, on the other hand, is tax deductible.

In the above example, first year interest on a $30,000 credit card balance is $6,000. First year interest on a $30,000 mortgage debt is around $2,100. However, if you are in the 30% tax bracket, you get to deduct the interest for the mortgage payment off of your gross income, giving you a tax savings of around $630. Therefore your real interest expense on the mortgage payment is 2,100 – 630 = $1,470. This is $4,530 less than the interest on the credit card debt in the first year. The minimum monthly payment for the credit card debt (3% of balance) starts at $900/mo and then decreases as the balance is paid down. The interest rate for a mortgage debt is much less than for credit cards. It is less than personal loans, car loans, boat loans, motorcycle loans, home improvement loans, business loans, and just about any other loan that you can think of. It is a loan secured by real estate – the most secure investment on the planet. AND, the interest is TAX DEDUCTABLE. 

Another word on credit card balances: IF you make only an absolute minimum payment of 2% of the remaining balance per month, with an interest rate of 17% : The following EXAMPLE would apply :

These numbers will change if your interest rate is different, or if you make more than the minimum payment. If you make new credit card purchases or incur fees such as late fees, over-limit fees, or cash advance fees, it could take even longer and cost even more to repay a credit card balance.

Thinking of starting a business ? 

Most businesses are started with self financing. See the equity in your home as a source of funding. You can refinance for 100% of the loan to value with very reasonable interest rates with no PMI. Most business banks require that the prospective owner put up a portion of the invested capital. They will not finance you 100%. Interest rates are higher than mortgage rates. Business interest is tax deductible but so is mortgage interest.  

Unexpected Bills –

Say you have a loan out by way of your 401K plan at work. You loose your job. Generally, you must pay back that loan within 90 days or face a 10% penalty tax for early withdrawal AND pay taxes on the withdrawal. If you are 59 ½ years of age or disabled, the government may give you a break on the penalty. If you borrowed $10,000, you will be hit with a $4,000 bill if you are in the 30% tax bracket. The State will take another 4%. Unplanned income tax or any other types of tax bills that the government sees fit to levy on you are also a bill that will not wait.   

Medical bills can be a problem. The fact that hospitals and doctors charge self paying patients 3 to 5 times what they charge Medicare and insurance companies does not help. The fact that they take advantage of a “captive audience” (as the chief of surgery at one Connecticut hospital put it) does not help. Still, they have a legal right to try to collect.  I would question and attempt to negotiate down every single line item on their bill. If this doesn’t work, refinancing to pay a discounted settlement may be the best alternative. PS - if you are hit with large bills, I strongly suggest that you consider refinancing as an option before resorting to bankruptcy.

Lawyers often seem incapable of any sort of movement, physical or mental, and let alone any sort of actual work, unless they are paid. I always remember that Mel Brooks movie, History of The World, where a lawyer is trying to speak but can’t, and can only grunt, until Mel Brooks pays him. If you or anyone in your family run into any legal problems, be sure that the attorney will want to get paid. Their bills can be large. While a nice attorney may give you a mortgage on your home for a 15% interest rate with 2 points up front, and a balloon payment in five years, to cover his fee, I think that you can do better by refinancing.

Estate taxes can be quite a burden. It’s like the government is taxing you twice, at least! The money has already been earned and taxed. Now they want more.

Supposedly, the estate tax is due to expire in the year 2010. Personally I don’t believe it. This is like a promise from a school of sharks to stop biting people in the year 2010. The government is still going to be hungry in the year 2010. Maybe even more so! If you are hit with an estate tax, you should consider refinancing the real estate as an option. It is not the only option, but it may beat selling the property outright.

While we are on the subject of estate planning, I would strongly suggest that you have a will. Don’t let the government even get a shot at your assets, no matter how small. I would also suggest a living trust in order to avoid the agonies of probate. It will not help you avoid taxes, but it will save on agony and attorneys fees which you may incur during the probate process. If your estate worth over $600,000, I would also look into tax advantaged trusts. 

You’ve owned an investment property for 20 years. You paid $200,00 for it and now it’s worth 1 million. You keep getting offers on it. People are begging you to buy the building. The problem is that if you sell, you must pay recaptured depreciation plus capital gains to the IRS.  You want to raise cash for another project. The solution is to refinance the property and take cash out. No need to pay the tax man. Talk to a CPA and get a comparison of selling vs refinancing.

Asset protection – Connecticut is NOT a homestead state. That means that your home is a target for lawsuits, bill collectors, and anybody else who wants your money. Florida, on the other hand, IS a homestead state. That means that you can owe millions of dollars and no one can touch your home – in Florida. In Connecticut, just because you are a good person, never bother anyone, stay out of trouble, and pay your taxes, does not mean that you may find yourself in some lawyer’s sights some day as an unwilling target. According to a very prominent Hartford malpractice attorney, over 60% of the lawsuits filed in the United States are frivolous. That does not mean that being sued will not cost you money. If you have sue-worthy assets, including the equity in your house, and are in a business where you are more likely to get sued than say a hermit, you need to consider an asset protection plan. Refinancing your real estate and transferring the cash to a safe haven will make the sharks think twice before going after you. The best book I have ever read on asset protection is Asset Protection Secrets by Attorney Arnold Goldstein, published by Garret Publishing, Deerfield Beach Florida in 1993. Phone number is 305-480-8543.You can probably pick up a copy at a good bookstore like Boarders or Barnes and Nobles. A friend of mine paid over $500 for a book and a video tape series on the subject and after reading Goldstein’s book, which I lent him, told me that he had wasted his money, or at least $470 of it. The book sells for around $30 and is well worth it.   

Owners Part And Go Their Separate Ways –

Relationships in business or in our personal lives don’t always work out. Real estate may be owned jointly in many forms, but the fact is that one person owns a portion of the real estate and the other person owns another portion. Rather than sell the property outright, it is sometimes wise for the remaining owner to refinance the property and buy out the other partner(s). You save a 6% sales commission and one party may simply not want to move. This is common in the case of dissolution of marriage (AKA divorce). In the case of a business relationship, one owner may be retiring or ready to pursue other interests. Selling the real estate may mean selling the business. Refinancing to buy out the other owner often makes good sense both in residential and commercial real estate holdings. 

Increase Cash Flow, SEP Contribution, IRA Contribution More Cash for 401K Contribution -  

Ever want to own a bank? Ever want to borrow low and invest high? You can. In the following example, I have projected out the affects of depositing $400 per month into a tax free account for various time periods at a 12% rate of return and at a 15% rate of return. (I dare not go any higher because some of you reading this may have a heart condition).

Some mortgage products allow you to have a greater cash flow than a 30 year fixed mortgage and are pretty stable. I prefer mortgages based on the COSI (Cost of Savings Index) which is an index based on the return on savings deposits, checking accounts, and 5 year CDs. At least, you should, shift your debt around from high interest credit card debt to low interest and TAX DEDUCTABLE mortgage debt to attain a better positive cash flow. If you do this, however, you may have a new problem – what to do with the extra money at the end of the month? SEPs, 401Ks, IRAs are an excellent way of saving money for retirement. You can actually take money out of an IRA to make a mortgage payment if you need to (IRA regulations and conditions apply). You can deduct your contributions from your gross income in many instances so that  you get multiple benefits! From studying the tax codes, I would say that the government wants you to own a home, wants you to shift debt to your mortgage, does not like credit cards, and wants you to save money in a non-taxable account.                               

Don’t think that 12% return per year is realistic ?

Different Terms -

Some people feel more comfortable with a fixed rate mortgage. They rest easier knowing that their rate can never go up during the life of the mortgage. They are willing to pay a higher rate, at present, to insure this. Other people, want a bigger positive cash flow. They are willing to take on the risk that their interest rate may fluxuate over the years. Other people want a more flexible payment option that allows negative amortization in order to increase their cash flow for a number of years to pay down credit card debt or invest in IRAs, 401Ks, SEPs, or some other retirement vehicle. Maybe someone didn’t’ t quite qualify for a 30 year fixed mortgage at a good rate at the time they took their mortgage and bought their house They have made their payments faithfully for two years, read my report, Credit Scores – What They Mean And How to Play The Game, and now want to refinance and use a different product.