World finances are changing not just by the day, but also by the hour and even minute at times. Still, life does go on, and interest rates are falling (at least as I write this) in an attempt to stimulate the economy and lending. So, it may actually be a good time to take advantage and refinance the existing mortgage on your farm.
Because each situation is unique, it is difficult to say what will work for you. If you are considering refinancing or taking out a line of credit, talk with your financial advisor or loan officer. He or she can sit down, go through your paperwork, and establish the best course of action based on your needs.
Types of Mortgages
Before deciding if you should refinance, it is best to understand what type of mortgage you currently have. Charna Moore, founder of Brighter Future Now (www.brighterfuturenow.com) outlined the four common types of mortgages in a recent mortgage seminar.
1. Conventional: This is the traditional type of mortgage where you have a fixed rate, typically over a 30 year term. You qualify based on how much you can pay monthly for your income level. The amount you pay is the same every month for the life of the loan. Because of this, it is more difficult to get in over your head. Initially, the interest rate will be a bit higher than other loan types, but you will likely save money in the long run.
2. ARM (Adjustable Rate Mortgage): This type of loan, which offers various terms, became very popular in recent years. It’s one of the main contributors to the financial meltdown. That’s because, in an ARM, the interest rate and how often it changes can both vary significantly. The initial rate is usually lower than the conventional rate, so you may qualify for a larger loan. However, you can end up owing more than you can really afford when the terms change and the interest rate increases. On the other hand, if the interest rate goes down, you will benefit. This type of loan can work well if you plan to move or refinance before the interest rate changes, or if interest rates drop even further. In the current economic climate, though, this does not seem likely.
3. Option ARM: The option ARM is even more risky than the ARM described above, and it, too, contributed to the current economic mess. Here you pick your payment amount, but the interest rates can skyrocket. If that happens, it is possible that the payment amount you chose will be less than the interest on the loan. In that case, your unpaid interest is added to the total amount you owe, and you get further and further behind. If this is the only way you can afford to finance a house or farm, chances are you really can’t afford it at all.
4. Interest-Only: Like the option ARM, this is a risky type of loan that can get you into trouble. You pay just the interest the first few years, after which time the principal is added into the payment. Again, if you can only afford the interest payment, you’re probably financing more than you can afford.
When to Refinance
If you have an ARM loan that is due for a rate change, or a conventional loan at a higher interest rate than what is being offered today, is it a good idea to refinance? Jim Moss, loan officer with MetLife Home Loans, suggests you take a look at your current mortgage and ask yourself why you would want to refinance. Do you just want a better rate, or do you need to do it because you want extra money for the facility? “If the answer is to get a better rate, I would recommend that you try to get at least one percent better in rate,” says Moss. “Anything less doesn’t really change a whole lot in terms of a lower payment.” If, on the other hand, you are looking to make facility improvements, add a new building, buy a horse, etc. Moss suggests looking at a cash out refinance. This would allow you to take enough money out from the current equity in the facility to pay for other things. “However, with the current declining values, I would not recommend going over an 80 percent loan amount to value,” warns Moss. “Most banks will penalize you in pricing if you go over 80 percent. By not going over that 80 percent you also can rest better, knowing that you still have a nice amount of equity.”
If you currently have an ARM and are thinking of refinancing to a fixed rate, ask yourself how long you plan on keeping the property. If the answer is five years or less, Moss feels an ARM could work well. “Most of the time ARMs offer a lower monthly payment, which would allow you to put the extra money into other investment options that may pay back higher dividends,” he says.
Those expecting to stay at their place for more than five years should consider a fixed-rate mortgage. This is also a good option for people who are more comfortable knowing their rate won’t change. Moss says that current pricing and recent market changes often make rates on fixed-rate loans lower than on ARMs. For that reason, you would have a lower monthly payment with the fixed rate.
Refinance vs. Line of Credit
A big advantage of equity lines right now is the low interest rates they offer. Each time the federal government lowers the key interest rate, it lowers rates on equity line interest rates. Of course, the reverse is also true—as the government raises interest rates, as it will inevitably do, rates will rise. In today’s market, Moss says a refinanced rate will be comparable to the current rate with an equity line. Which is better? That depends on each person’s situation.
Buying Points or Origination Fee
If you want to buy the interest rate down, you can choose to pay a discount point or an origination fee, both of which are one percent of the loan amount. (In other words, you increase the cost of your loan by $1,000 for each $100,000 you finance.) The main advantage of this would be to lower your monthly payment. However, according to Moss, it takes four to five years to recoup the money spent to buy down the rate. So, if you plan on being on the property less than five years, Moss does not recommend this option. If you do pay point(s), this amount may be tax deductible. Talk to your tax accountant about that.
The Big Picture
The choice of whether or not to refinance, take a line of credit or do nothing at all is very much an individual decision. The wisest move would be to consult with a professional who is well-versed in the areas of credit and mortgages. He or she can put together your credit score, equity, current mortgage, and plans for the future to determine the best path to take. With some patience and focus on your goals, you can manage your way through these turbulent times.
What about your credit score?
In order to qualify for a loan, you need a credit score around 680 (the highest possible score is 850). Your credit report is used to calculate your credit score and also helps determine what interest rate will be offered on your loan. It is a snapshot of your financial life on a particular day, and varies depending on when your creditors send out their data. You are entitled to one free credit report a year, and taking a look is very important to maintain the accuracy of your records. You can get a copy of your credit report from Equifax, Experian or TransUnion.
When you receive your credit report, it is important to review it carefully. Make sure all of your personal and employment information is accurate. Go over all the details about your listed accounts to make sure they are correct. If you encounter any mistakes, the first step is to send a letter to the credit bureau listing the errors and how you think the information should be listed. The agency has 30 days to get back to you. If they agree with the creditor but you believe otherwise, you will have to get in touch with the creditor to work on the situation.
Monitoring your credit report is an extremely important step that should be done once or twice a year. This is critical not just for accuracy, but also to find out if your identity has been stolen. The faster you are able to recognize a discrepancy, the easier it will be to fix.