Calculating The Net Benefit Of A Refinance Transaction
Calculating the net benefit of refinancing can be a challenging task if you do not understand what to calculate. We are going to focus on the net benefits of refinancing from the standpoint of lowering your interest rate.
Although there are several reasons to refinance, lowering your mortgage rate to save on interest payments over the term of the loan is the most popular.
Calculating the actual savings can be a tricky chore unless you know the difference between cash flow savings and interest savings. If your refinance objective is to only save on the interest by lowering your rate, then the interest savings should be done with the calculations below.
Calculating Interest Savings:
(Loan Amount x Interest Rate) / Months in year = Interest paid per month
($200,000 x 6% or .06) / 12 = $1,000.00
*Remember to do the calculation in the parentheses first*
We now know that you are paying $1,000.00 per month in interest. You should take the new interest rate you are getting with your refinance and calculate what your new interest payment will be.
($200,000 x 5% or .05) / 12 = $833.34
Now we need to find out the difference between the two interest rates.
Current Interest Payment – Proposed Interest Payment = Interest Savings
$1,000.00 – $833.34 = $166.66
Now you have figured out that by dropping your interest rate 1% on $200,000 you will be saving $166.66 per month or about $2,000 per year.
Awesome!
Anyone would want to save $2,000 per year, where do I sign… right? Not so fast, you’ll want to calculate the break-even point to find out how you will benefit after your closing costs.
Net Benefit Formula (Break-Even):
(Closing Costs – Escrows) / Interest Savings = Month of Break-Even
($6,000 – $1,000) / $166.66 = 30 Months
In other words, it will take 30 months for you to recoup the cost of your refinance. If you plan to keep your mortgage for at least 30 months then you might want to consider this deal.
Okay, now we can calculate your net benefit for refinancing with one more calculation.
(Monthly Savings * Months you plan to keep mortgage) – (Closing Costs –Escrows) = Net Savings
($166.66 * 120 months) – ($6,000 – $1,000) = $14,999.20
If you kept the mortgage for 120 months (10 years) you would save $15,000.
Okay, now you can find out where to sign.
Calculating the net benefits of a refinance is crucial in determining if it is strategic for you to refinance. Keep in mind that each mortgage is slightly different and you may need to adjust calculations accordingly.
……
Frequently Asked Questions:
Q: I heard that I should only refinance if I drop 1% on my mortgage is that true?
Some people say ½% , 1% to never. Every mortgage is different.
For Example: A no cost loan can have a 1 month break-even point with only a .25% drop in interest rate. Now that you know how to calculate your net benefit, you are able to figure out what may be best for your situation.
Q: Why can’t I just compare my current payment to the proposed payment and figure out my net benefit?
You could just compare just the two payments if you wanted to find out your cash flow savings, but the current and proposed loans may have two different amortizations.
Let’s assume you currently have a 15 year mortgage and you’re comparing it to a 30 year mortgage. If both loans have the same interest rate and loan amount but the amortization is different, your interest savings per month would be $0. However, you are going to show a cash flow savings with the 30 year mortgage because of the longer amortization.
_________________________________
Related Article – Refinance Process:
- Refinance Process Overview
- Mortgage Approval Process
- Four Possible Reasons To Refinance
- Should I Refinance Or Get A Home Equity Loan To Make Improvements?
- What Do Appraisers Look For When Determining A Property’s Value?
- Understanding The Difference Between Appraised Value vs Neighborhood Listing Comps
- Five Myths About Home Values
March 28, 2010 by Chris Zimmerman · Leave a Comment
Understanding the Difference Between an Appraisal vs Neighborhood Listing Prices
Why is there such a difference between what my appraised value is and the price similar homes are selling for on my street?
It’s a great question, and you don’t have to be a mortgage professional or a real estate agent to understand the answer.
The distinction lies in the purpose of the two valuations and who is responsible for creating them.
The purpose of an appraisal is to make sure that an independent non-interested third party verifies the “most likely” sale price based on the market value and condition of the home.
Appraisals are meant to be a realistic determination of the value of a home if it were to sell in the current market, in its current condition.
In addition, appraisers are governed by rules intended to standardize the subjective process of determining a home’s value.
Some of the key factors appraisers look at are: location, above ground size, room count, bathroom count, style of home, condition of property, amenities, and market conditions such as how long it takes for home to sell and if values are increasing, decreasing or steady.
Appraisers are also asked to look only at comparable sales within a certain distance, usually one mile except in rural areas, and within a specified period of time, which is 3 months in the current market.
Listing Prices:
Listing prices on the other hand are influenced by the real estate agent, and set by interested and often emotional sellers.
Sellers are not held by any rules when they list a home. In some cases, sellers take what they paid for the house, add what they have spent on improvements and even add amount for profit.
Often times, sellers will list their home based on the amount needed to pay for the real estate agent, closing costs and cover the amount of the mortgages.
Extra low prices are generally the result of an extra motivated seller that has to sell and move in a rush, so they’ll list their property below market comps in order to be the most competitive.
Throw in bank owned homes (foreclosed properties), and listing prices may be all over the place without a logical explanation due to an asset manager making decisions from another part of the country.
The Verdict:
While list price is never a good indication of what a home in your neighborhood is worth, appraisals are not an exact science that will determine the true value of your home either.
Some will argue that a home is worth what people will pay for it, so there’s obviously a little room for personal interpretation. Either way, the bank securing that piece of real estate for a mortgage loan generally always has the final opinion that matters the most.
_________________________________
Related Appraisal Articles:
- Mortgage 101 – Appraisal Basics
- What Do Appraisers Look For When Determining A Property’s Value?
- Five Myths About Home Values
- How Do Mortgage Companies Value A Property That Hasn’t Been Built Yet?
March 28, 2010 by Chris Zimmerman · Leave a Comment
Making Sure Your Cash-To-Close Comes From The Proper Source
Providing proper asset documentation and the actual source of the funds is a critical element of the loan closing process.
There’s nothing worse in a real estate purchase than making it all the way through the hoops and hurdles just to have a loan denied after the final documents have been signed due to the borrower using the wrong checking account for the down payment.
Seasoning of the down payment money is just as important as the source, which is why underwriters typically require at least two months bank / asset statements in the initial mortgage approval process.
A Few Acceptable Sources Of Down Payment Include:
- Bank Accounts – checking / savings
- Investment Accounts – money market, mutual funds
- Retirement Funds – keep in mind that borrowing against a 401K plan will require a repayment, which will be calculated in the Debt-to-Income Ratio
- Life Insurance – Cash value and face amount
- Gifts – Family members can gift down payment funds with certain restrictions
- Inheritance / Trust Funds
- Government Grants – Many state, county and city agencies offer special down payment assistance programs
It is extremely important to make sure your loan officer is aware of the exact source of your down payment as early in the process as possible so that all necessary questions, documentation and explanations can be reviewed / approved by an underwriter.
A good rule-of-thumb to remember is that whatever funds you’re using as a down payment have to be pre-approved by an underwriter at the beginning of the mortgage approval process.
Basically, if you accidentally forget to deposit money in your checking account on the way to the closing appointment, it is not acceptable to get a cashier’s check from a friend’s account until you have a chance to pay them back later.
……
Frequently Asked Questions:
Q: What if I don’t have a bank account and cannot properly source my funds to close?
Cash on hand is an acceptable source of funds for some loan programs, but make sure you bring that detail up at the application stage
Q: Can I use a bonus from my employer for my down payment?
Yes, but generally this needs to be a bonus you regularly receive
Q: Can I borrow the money from a friend?
No, any money that needs to be repaid is typically an unacceptable source of funds
_________________________________
Related Articles – Closing Process / Costs
- Closing Process – Overview
- Closing Costs – Overview
- Talk the Talk – Know the Mortgage Lingo at Closing
- Where Does My Earnest Money Go?
March 28, 2010 by Chris Zimmerman · Leave a Comment
Talk the Talk – Know the Mortgage Lingo at Closing
What the heck are they talking about?
Many borrowers go through the closing process in a haze, nodding, smiling, and signing through a bunch of noise that sounds like Greek.
Even though you may have put your trust in your real estate and mortgage team, it helps to understand some of the terminology so that you can pay attention to specific details that may impact the decisions you need to make.
Common Closing Terms / Processes:
1. Docs Sent –
Buyers sit on pins and needles through the approval process, waiting to find out if they meet the lender’s qualification requirements (which include items such as total expense to income, maximum loan amounts, loan-to-value ratios, credit, etc).
The term “docs sent” generally means you made it!! The lender’s closing department has sent the approved loan paperwork to the closing agent, which is usually an attorney or title company.
Keep in mind that there may be some prior to funding conditions the underwriter will need to verify before the deal can be considered fully approved.
2. Docs Signed –
Just what it implies. All documentation is signed, including the paperwork between the borrower and the lender which details the terms of the loan, and the contracts between the seller and buyer of the property.
This usually occurs at closing in the presence of the closing agent, bank representative, buyer and seller.
3. Funded –
Show me some money!
The actual funds are transferred from the lender to the closing agent, along with all applicable disclosures.
For a home purchase, if the closing occurs in the morning, the funds are generally sent the same day. If the closing occurs in the afternoon, the funds are usually transferred the next day.
The timing is different for refinancing transactions due to the right of rescission. This is the right (given automatically by law to the borrower) to back out of the transaction within three days of signing the loan documents. As a result, funds are not transferred until after the rescission period in a refinancing transaction, and are generally received on the fourth day after the paperwork is signed.
(Note – Saturdays are counted in the three day period, while Sundays are not). The right of rescission only applies to a property the borrower will live in, not investment properties.
4. Recorded –
Let’s make it official. The recording of the deed transfers title (legal ownership) of the property to the buyer. The title company or the attorney records the transaction in the county register where the property is located, usually immediately after closing.
…..
There you have it – an official translation of closing lingo.
As with any other important financial transaction, there are many steps, some of which are dictated by law, which must be followed.
_________________________________
Related Articles – Closing Process / Costs
- Closing Process – Overview
- Closing Costs – Overview
- Making Sure Your Cash-To-Close Comes From The Proper Source
- Where Does My Earnest Money Go?
March 28, 2010 by Chris Zimmerman · Leave a Comment
Five Myths About Home Values
During periods of economic growth, when home values are typically just going up, most homeowners do not question appraisals much.
And in times of turmoil when property values are declining, home sellers and even listing agents quite often question and pick apart appraisals.
However, the actual appraisal process changed very little over the course of the housing boom and bust cycle American homeowners witnessed between 2001 – 2009.
Since the topic of home values seems to be a hot discussion, let’s address the top five appraisal myths.
Appraisal Myths / Questions:
“I just put $15K into the property, why isn’t the appraised value higher? ”
Not all improvements to the property are equal in producing added value. A local real estate investment club used to tout buying a run-down, roach-infested property cheap, and after de-bugging and adding a fresh coat of paint and carpet – *presto* – the house would appraise like the new homes up the street.
Even with cosmetic repairs, the property may still be much more comparable to the foreclosure next door than the new home a block away. Look first to the “guts” of the property, the electrical, heating & air, etc. If they are updated, then the number of beds/baths and square footage are the next biggest weight, followed by a genuine updating of cosmetic improvements.
“But my home really compares to some of the properties in the neighborhood across the way…”
For example, if a homeowner preparing a house to sell adds $150,000 in upgrades to the kitchen, built-in cabinets and flooring, it may help the property show better in an open house and in magazine advertisements.
However, the seller might still be stuck with a $450,000 appraised value like the three comparable properties on their street vs the $750,000 they were hoping to list it for.
Even though the neighborhood across the main street had similar homes in the higher price range, especially after the seller’s extensive upgrades, appraisers will always use homes from the actual neighborhood to establish value first.
So basically, the seller simply over-improved their home for their specific neighborhood.
“This appraiser included foreclosures as comps – that’s not fair”
It isn’t fair, especially if your home is well-kept and in great condition compared to the run-down foreclosures in the neighborhood.
Unfortunately, if every recent sale, or nearly all sales, are foreclosures at reduced prices, then the appraiser is forced to use the recent sales and trends as comparable values. High foreclosure rates generally depress values and show a trend of lowering prices.
And abnormally high foreclosure rates generally depress values and show a trend of constantly lowering value.
“But I just put in a $50K pool, doesn’t that count for anything?”
Pools and professional landscaping rarely see a dollar for dollar value add on a property. The value is going to mainly be based on comparable sales in a neighborhood.
“How can similar homes in the same neighborhood appraiser for such different values?”
This is a typical question for older neighborhoods where similar models may have drastic price differences.
Additional rooms and square footage can be the main reason for one property appraising higher than another.
Keep in mind, just because the market trend in a particular neighborhood is improving over time, the individual properties need to meet the same conditional improvements as the others in order rise with the tide.
…..
An appraiser is looking at several things when determining the value of a property: improvements, size and square footage of the living area, neighborhood amenities, location and the market trends around the area.
_________________________________
Related Appraisal Articles:
- Mortgage 101 – Appraisal Basics
- What Do Appraisers Look For When Determining A Property’s Value?
- Understanding The Difference Between An Appraisal vs Neighborhood Comp
- How Do Mortgage Companies Value A Property That Hasn’t Been Built Yet?
March 28, 2010 by Chris Zimmerman · Leave a Comment
How Do Mortgage Companies Value A Property That Has Not Been Built Yet?
It’s obviously easier to picture the process of estimating value on an existing property in a neighborhood that has a history of home sales, but the task of determining the value on new construction projects does pose some challenges.
Appraisals on homes that haven’t been built yet generally require the contractor and home buyer to supply more documentation in order to get a more accurate estimate of the property’s value.
The main purpose of this article is to give an overview of the appraisal process for a home buyer that is building a home vs purchasing standing inventory.
For some, building a new home can be both exciting and overwhelming. Watching a project transform from idea to completed home with a front yard, white picket fence and a custom red front door is a rewarding experience.
Even if you are paying attention to all of the information from the beginning, there are still several details that have a tendency to catch even experienced builders off guard.
Game time decisions have to be made as cabinets and corners line up differently than the initial drawing could show, flooring doesn’t match the wall colors, or the sun hits a window the wrong way at dinner time.
While the last minute updates may cost you more money, they might also have an impact on the value of the property.
What Does An Appraiser Need For New Construction?
Plans –
The plans or construction drawings are usually done by your builder or architect. It lays out the floor plan of your home, sizes of rooms and square footage of your home.
They should include a floor plan layout, front elevation, real elevation & side elevations, mechanical and electrical details.
Specifications / Descriptions Of Material –
A “Spec” sheet has the type of construction materials you will be using. For example, whether your home will be built with standard 2 x 4’s or 2 x 6’s.
It also contains the type of insulation, roofing and exterior products that will be used in the construction, as well as floors, counter tops and appliances for the inside dressing.
Cost Breakdown –
The document that breaks down all of the costs associated with the construction, including land, building materials and labor.
A lender can generally provide you with blank forms for the spec and cost breakdown if your builder does not have them.
Plot Plan –
Shows where your home will sit on the site, any accessory buildings, well and septic locations, if applicable, and the finish grade elevations and direction of the drainage.
Once the lender has obtained the above information from you, they will forward a copy to the appraiser. It is the appraiser’s job to determine what the future value of the home will be once it is completed, per your plans, specs & cost breakdown.
Even though an appraiser will use the cost approach in the appraisal report, it is not the value that will ultimately be used by the lender. The market approach to value, which uses existing sales of homes similar in size, quality, construction and location is the most common approach that lenders want for new construction.
The more complete and detailed your plans, specifications and cost breakdowns are, the more accurate your appraisal will be.
Once your home is complete, the appraiser will be asked to go out and inspect the home. They will report back to the lender what they have found, whether your home was completed according to the plans and specifications originally given, and if the value is the same as originally given in the report.
Sometimes the value has to be adjusted due to changes that were made during construction which may have affected the value of the home.
…..
Frequently Asked Questions:
Q: Where can I obtain a set of plans?
Most builders have basic plans they work from, and make modifications specific to their clients’ needs. When building a custom home, it’s generally a good idea to work with a reputable architect.
Q: Is there a form I can use for the list of specifications?
Yes, HUD has a generic form that most lenders use and it will give the appraiser most of the details they need to complete your appraisal. Anything not listed on this form can be added by you separately on an additional sheet.
Q: Can I use my contract with the builder for the cost breakdown sheet?
In most cases, the lender will accept the contract, however, they will want the builder to provide a cost breakdown to ensure that the builder has accurately bid your home.
_________________________________
Related Appraisal Articles:
- Mortgage 101 – Appraisal Basics
- What Do Appraisers Look For When Determining A Property’s Value?
- Five Myths About Home Values
- Understanding The Difference Between An Appraisal vs Neighborhood Comp
March 28, 2010 by Chris Zimmerman · Leave a Comment