Preparing to Refinance

When I purchased my new home about a year ago, I went with the builder’s preferred lender because of the lower closing costs with the incentives. Because I also hadn’t yet sold my prior home and really had no cash to put down, I did 100% financing with an 80/20 loan. What’s an 80/20 loan? Well, if you have excellent credit, it is a method of doing 100% financing and avoiding having to pay PMI. It is actually two loans. A primary mortgage for 80% of the value and a second mortgage for 20%. Because the loan-to-value on the first mortgage is 80%, you do not have to pay PMI. Another thing I did was make the primary mortgage interest-only for five years.

Never in a million years would I ever recommend someone do 100% financing with interest only loans, especially in this market! So why did I use this kind of financing when I would never recommend it? First of all, I had plenty of equity in my old home. I owed $190k and ultimately it sold for $290k. Even if I hadn’t sold it, I could have rented it for break-even.

I also anticipated that my prior home wouldn’t sell before closing on the new home (and I was right). I wanted to be able to pay down the mortgage on the new home and be able to improve my monthly cash flow, which is why I did interest-only on both loans. If I had bought the new home with a fixed mortgage, paying down the mortgage would reduce the balance but the payment would remain the same. Paying down a fixed mortgage reduces the amount of time to pay it off and reduces the total interest paid over the life of the loan.

Do I have any regrets? The interest rate on the first mortgage is 6.625%, which seems a bit high to me, especially for a 5-yr fixed period and adjusting after that. I wish I had shopped around a bit for similar terms but at a lower rate. Mortgage rates have been on a fairly steady decline since the middle of last year, so I will likely be refinancing this spring or this summer.

I’ve been keeping an eye on the 30-year Treasury Bond. Although not the same rate, fixed mortgage rates trend similarly to long-term treasury bonds and notes. The yield on the treasury bond also sometimes trends with the stock market indices as well. The 30-year bond hit a low in January right behind the Dow Jones Industrial Average. I’m looking forward to the next time Wall Street has a tough time with economic reports, because it may present the perfect refinancing opportunity.

Shopping for a mortgage can be tough. I had been using BankRate’s mortgage comparison tool for a while, until I came across Yahoo!’s. I like Yahoo!’s better because it allows you to enter an estimated range for your credit score (only has three ranges, but it’s better than 0). It also allows you to filter the results based on the term, monthly payment, points, lock term, and fees. The best feature of all is that the results are a single click away, rather than having to click through several screens on BankRate.

I’ve also been working on improving my credit score. I want to watchdog my score over the next month, so I’m trying out myFiCO’s ScoreWatch free for 30 days. It allows you to monitor your credit score, and when it changes you can receive alerts. Overall, ScoreWatch seems like a pretty good product, although I’m very disappointed in the simulator. You can try different scenarios to see how it improves your credit score, but it gives you a large range for the result (20 points or more) rather than an exact score. You would think that the people that invented the FICO score would be able to give you an exact number! I simulated paying my credit card balance in full, and the result was a score of 760-780. Not very helpful since I already have a score in that range, albeit on the lower end.

ScoreWatch is certainly a great thing to have if you’re looking to refinance soon. Right now my score is 760, so I’m basically right on the line of the top-tier for a 30-year fixed mortgage. I’d like to get just a little bit over the line. Although I never carry a balance on my credit cards, because there is a balance when the statement closes (that I subsequently pay off in full), it appears as a balance on my credit report. I use only one credit card to take full advantage of cash back. This month I’m going to experiment and try paying the balance in full (or as close as I can, give or take a few transactions) before the statement closes. We’ll see if it improves my score.

The last thing I’m doing to prepare is paying down my current mortgage as much as possible. At the end of last year, I used my annual bonus to pay it down considerably. I will be filing my tax return soon, which will also provide a few thousand to pay it down a bit futher. My goal is to get it down to about $150k before refinancing. Right now it is sitting at $168k. Between some cash I have in brokerage accounts, my checking account, and the tax return, I think I should be able to get very close to $150k. I want to have as small of a balance as possible because it will also mean a smaller monthly payment after I refinance. I would be very comfortable with a $150k balance, because I could likely rent out my home at some point in the future for positive cash flow.

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