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Ballooning Balance

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Posted On: 01/26/2011

QUESTION:

We refinanced our home to get a better rate. The amount borrowed was exactly the same as the old loan balance, and yet the new loan is a little larger. How come?

ANSWER:

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In some cases it may be that the lender added closing costs to the loan amount so that you will need little if any cash at closing.

Another possibility concerns the way mortgages are paid off. Home loans are paid in “arrears,” meaning that the monthly payment made on January 1st is used to offset loan interest owed for the month of December.

Most likely you will miss a monthly mortgage payment by refinancing. However, while you will be able to skip a payment (and sometimes even two payments, something that just happened to me) interest on the loan continues on a daily basis. The higher principal balance will reflect the unpaid interest for the payments not made.

QUESTION:

Whatever happened to the old rule that said you should never refinance unless rates fell at least 2 percent?

ANSWER:

You can safely ignore the 2-percent rule. With today’s “no cost” refinancing – deals where up-front costs are paid in the form of a somewhat above-market interest rate – it can make sense to get a new loan if monthly costs fall and you expect to remain in the property for several years.

Example: You have a $200,000 mortgage at 5.5 percent. The monthly payment for principal and interest is $1,136. After five years you refinance at 4.75 percent. The new loan balance is $183,761. The new cost for principal and interest is $931, a monthly saving of $205. The cash cost to refinance is zero or close to it.

If you like, prepay the new mortgage for even bigger savings. At $1,136 per month and 4.75 interest the new loan can be paid off in 249 months – nine years early.

For details, ask your lender for specific figures.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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