In a recent article, I suggested that a home buyer with enough money to pay all cash, but who needed to recover some of the cash for other purposes, might do better to pay all cash and refinance later. I did point out that the rate on a cash-out refinance would be a little higher than that on a purchase mortgage, but this might be less compelling than the greater ease of shopping for a refinance.
Astute readers pointed out some other differences between a purchase mortgage and a refinance that might well tip the advantage in the other direction.
1. The tax laws view these two transactions very differently. On a purchase loan (the Internal Revenue Service calls it “acquisition indebtedness”), interest is deductible on loan balances up to $1 million, and on a refinance (“equity indebtedness”), deductibility cuts off at the $1 million level. Similarly, on a purchase loan any points paid on the transaction are wholly deductible in the transaction year, but on a refinance, points must be prorated over the term of the loan.
2. In some states (including California), if a purchase mortgage goes into foreclosure and the property value is not sufficient to make the lender whole, the lender cannot obtain a deficiency judgment that allows it to go after the borrower’s other assets. The borrower has no such protection on a refinance.
3. The borrower purchasing title insurance when buying the property will nonetheless have to buy a policy for the lender when refinancing. Typically, the two policies purchased separately will cost more than two purchased together.
4. Having a lender involved in a purchase decision can sometimes save the borrower some grief. An example is the purchaser of a condominium who discovers that the project does not meet the lender’s guidelines for reasons that are as relevant to the buyer as to the lender. For example, too many units in the project remain unsold.
5. On the other side of the ledger, I must mention the possibility of getting the best of both worlds, even though I am not yet sure how many borrowers can take advantage of it. Irving Steinman, a mortgage broker in Los Angeles, tells me that he has brokered many “technical refinances,” which occur within 90 days of the purchase and are viewed as purchase loans by both the lender and IRS. Readers who can provide more information about technical refinances are invited to write to me.
KEEPING TRACK OF AN INTEREST-ONLY LOAN
Q: “I have an interest-only adjustable rate mortgage (ARM) on which I make principal payments as I am able. My problem is that I don’t know exactly where I am in paying off the mortgage–when it will pay off if I keep my principal payments at their current level, or how much additional I would have to pay to pay off by some specified period. Have you anything that will help me?”
A: One of the nice things about a mortgage on which you make the fully amortizing payment is that you know that if you keep at it, your balance will hit zero in the terminal month. When you take out an interest-only (IO), in contrast, you can lose sight of where you are, especially if the IO is an ARM on which the rate can change.
I have received so many letters about this that I finally bit the bullet and developed an IO spreadsheet, which can be used for both fixed- and adjustable-rate mortgages. It is the top spreadsheet on my Web site.
The spreadsheet allows you to see at a glance how a principal payment impacts the balance, the interest payment in the following month, and the fully amortizing payment. The last is important, because it is what you are obliged to pay when the IO period ends.
Like all my spreadsheets, this one can be downloaded onto your computer so you can maintain a permanent record close to home.
LOAN PROVIDERS SHOULD BE SELECTED LIKE WILD MUSHROOMS
Q: “How do I verify that a mortgage broker or loan officer has not been charged with being predatory or unethical?”
You can check with the Better Business Bureau and the state agency that licenses the broker or loan officer, but that is not a good use of your time. Very few misdeeds are ever reported.
You should select a loan provider the way I select wild mushrooms. I wouldn’t try to identify all the ones that might poison me; that is too risky. Rather, I have learned a few that I know are safe and I ignore the rest. I have adopted this philosophy in the “Find a Loan Provider” section of my Web site.
The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.
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