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Save Big Bucks on Your Mortgage

There's a bright side to the debt crisis that's plaguing Europe and increasing the risk of sinking the global economy into recession again: Interest rates on mortgages are at record lows.

But mortgage refinancing advice for today's home buyers and owners includes a few new twists.

On "The Early Show" Wednesday, financial adviser Ray Martin shared suggestions on negotiating those changes:

The fixed-rate mortgage with a 30-year term has traditionally been the most popular used by home buyers. But today's generation of home buyers may be well-advised to consider a 20-year mortgage. There are several advantages to doing this.

The biggest advantage is the significant interest saved over the term of the loan. Let's say you bought a home and took out a $200,000 mortgage with a 30-year term and an interest rate of 4.75 percent. The monthly payment would be about $1,043 and the total interest paid over the life of the mortgage would be about $175,600.

Alternatively, you could borrow the same $200,000 at a 4.5 percent interest rate. Mortgages with a 20-year term can carry a rate that is about a quarter of a percentage point lower. The monthly payment on this mortgage would be about $1,265 and the total interest paid over the life of the mortgage would be $103,670.

Take a closer look at the difference, and it is surprising. The 20-year mortgage in this example has a monthly payment that is only $222 higher. But the amount of interest paid is almost $72,000 less than the total interest on the 30-year mortgage, which is a significant amount saved.

Another advantage is that mortgage will be paid off ten years sooner. This can be a big advantage for young home buyers who are planning to have children. They can become free of mortgage payments just at the time their children going to college. This means they'll have more cash flow in time to help pay tuition bills.

Some home buyers will need to start with the more affordable monthly payment of a 30-year mortgage but want the savings of the 20-year mortgage. They can take out a 30-year mortgage and make an extra payment or two each year, which would lower the loan balance more quickly and produce almost the same result. Just make sure to instruct your lender in writing that the extra payments are to be used only to reduce the loan balance.

The New Refinancing Moves

Folks who already have a mortgage should consider their refinancing options now, while mortgage rates are at historic lows. Some of the same rules still apply (see below). But mortgage bankers are seeing a new trend in what's called a cash-in refinance.

When home values were rising, many homeowners tapped their homes equity by replacing a smaller mortgage with a larger one, taking the difference in cash. But now, more homeowners are doing the reverse, bringing cash to the closing table and replacing their larger mortgage with a smaller one. In fact, 22 percent of homeowners who refinanced in the second quarter opted for a cash-in refinance, the third highest level since Freddie Mac started tracking mortgage refinancing activity in 1985.

Cash-in refinancing is gaining more attention as folks see record-low mortgage rates as an opportunity to refinance and save money. In the process, more people are paying down their mortgage, as they see doing so as the best use of extra cash. Banks and money market funds pay less than one percent and the stock market can expose them to big losses.

There are several other very compelling reasons why it's worth it to shrink your mortgage when you refinance it. Here are a few:

Mortgages that are less than 80 percent of the homes appraised value escape the additional cost of private mortgage insurance.

Folks with mortgages that are a lower percentage of the home's value (60 percent or less) and have higher credit scores (740 or more) can qualify for the lowest interest rates on refinanced loans.

Banks charge a lower interest rate on mortgages below the conforming loan limit of $417,000 (and $729,750 in certain areas designated as "high cost") as opposed to rates on mortgages over these limits, the so-called jumbo mortgages.

Folks considering a cash-in refinance should also consider replacing their 30-year mortgage with a mortgage with a 20-year term. For some, it would be a mistake to refinance back to a typical 30 fixed mortgage when you are well into the first ten years of the term. The reason is because most of the payments in the beginning of a mortgage are interest and borrowers pay the most interest during the first 10 years of this type of loan. By refinancing back into a 30-year loan, you go through this high-interest period again.

Instead, refinance into a 15- or 20-year fixed rate mortgage. If you had a 30-year fixed mortgage for seven years, try refinancing to a 20-year mortgage. The lower interest rate will also help to make the payments on the 20-year loan more affordable.

30-Year Mortgage: Total interest paid over...

First ten years = $86,640
Next ten years = $63,256

20-Year Mortgage: Total interest paid over...
First ten years = $73,923
Next ten years = $29,747

This example assumes the same rates as in the above one.

A Few Refinancing Guidelines

New Interest Rate is One Percent Less: Homeowners who can reduce their mortgage interest rate by at least one percent should start looking into their refinancing options. Folks with adjustable-rate mortgages should not miss this opportunity to lock in the certainty of a low fixed-rate, even if their current rate is lower than the fixed rate.

Savings Recover Closing Costs in 24 Months or Less: If the savings created by your new lower mortgage payment recoups the closing costs in 24 months or less, and you plan to keep the home for at least that long, then refinancing can be worth it. If you refinanced in the last year or two, just be sure to consider any closing costs from your last refinance that have not yet been recovered.

Homeowners with larger mortgages should definitely look at refinancing again, even if they refinanced in the last year or two. The monthly savings from lower interest rates for larger mortgages are greater and can recover the costs of a refinancing more quickly.

Today's mortgage refinancing reality is that folks who are unable to prove their income and assets with verifiable documentation will struggle to find any reasonable refinancing options. Expect to provide full documentation of income and assets with your mortgage application. This includes pay statements from the past three pay periods, three months bank statements and tax returns for the past two years. Requirements may also include having cash in reserve equal to six-to-12 months of mortgage, insurance and tax payments. In most cases, 70 percent of retirement account balances count towards this requirement.

If you can provide documentation of the income and assets required, your credit score is 700 or higher, have no late payments, your mortgage loan amount is less than 80 percent of the homes appraised value, and the loan amount is not more than $417,000 (up to $729,750 in designated high-cost markets), then you'll have many refinancing options available.

Don't wait to catch the bottom in mortgage rates. If while you are waiting your financial condition unexpectedly takes a turn for the worse (you lose your job) then you may not qualify to refinance and could miss out on what could be the lowest mortgage interest rates you will ever see.

If your mortgage is almost as much as your home's value, or is underwater (where the home is worth less than the amount of the mortgage), refinancing may still be available through the government-sponsored Home Affordable Refinance Program, or HARP. This program allows mortgages financed by Freddie Mac or Fannie Mae, with loans up to 125 percent of the home's value to be eligible for this special refinancing program.

Some borrowers will not be able to refinance. For folks who are working, but are making a lot less than they were, or who are unemployed, refinancing is generally not an available option.

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