The Last Mortgage Refinance
What direction do you think interest rates are headed in?
Homeowners have ridden the variable interest rate mortgage ride for all it's worth. The prime rate hit 20% in 1980. Since then interest rates have been in a long and steady decline. Along the way, borrowers would refinance their house and take out more cash as the value of the property was rising. Times have changed just a wee bit. Declining interest rates gave borrowers the wind at their backs. The worm appears to have turned. It’s starting to look more like the classic 1980 Bob Seger song, "Against the Wind." Many variable rate mortgages had an annual cap of 2% and a lifetime cap of 6%. So, if a mortgage started out at 4% it couldn't go up to any more than 6% after one year. It also couldn't go higher than 10% after three years. So, while the variable rate mortgage made sense in a declining interest rate environment the past 30 years, it no longer seems appropriate.
If you have a variable interest rate, take a hard look at refinancing to a fixed rate.
Just to be clear, not everyone should refinance their variable rate mortgage. If you are planning on moving in the near future, the cost of refinancing may not justify it. You've got to “run the numbers” to see what the potential payback is.
Naturally, to refinance, you will need to have equity in the property. Even if you have equity in the property, refinancing can be a challenge. The underwriting rules have gone totally the opposite way from just a few years ago. It wasn't that long ago when all you needed was a pen to get a mortgage. As one of my friends said, "There's a lot of ink in this world." It's going to take more than a pen to get your home refinanced today. Lenders now want copies of W-2 Forms, paystubs, income tax returns, bank statements, and other documentation to approve a loan.
One of the advantages of mortgage interest on your residence is that it is tax deductible. However, there are a few limitations on this. The amount of interest deducted cannot exceed the interest on one million of debt when the property is bought or constructed. There is an additional allowance for another $100,000 in home equity line of credit interest. Mortgage interest can be deducted on your first (primary) and second home. Points paid to secure a mortgage on the purchase of your primary residence can be deducted in the year paid. Points paid to refinance must be amortized (expensed) over the life of the loan. Personal interest, which includes car loans, credit card debt, and other consumer loans, is not income tax deductible. This makes these loans even more expensive.
If you have a variable rate mortgage will you refinance it to a fixed rate mortgage?
Thomas F. Scanlon, CPA, CFP®