If the walls are closing in on you at home, you may be experiencing “homeowner shrinkage.” Often experienced after living in the same dwelling for several years, homeowners may eventually feel as if their house has decreased in size and would like to trade up to larger house. The dilemma many homeowners encounter is whether to sell their home and trade up or refinance their mortgage.
Additionally other factors come into play such as job stability, family dynamics, current mortgage payments and market conditions. Each factor should be considered very carefully, weighing finances with current and future life goals in order to make the smartest decision.
Should You Just Refinance?
With rates hitting rock bottom, nearly every homeowner has already refinanced their mortgage loan or is seriously considering it. Let’s use the scenario of the homeowner who owes $140,000 on her mortgage loan, with only seven or eight years of payments remaining. The homeowner currently has a 15 year-mortgage at a 5% rate.
After crunching the numbers the homeowner has a few choices. She could refinance the 15-year mortgage at 3.3% and save about $18,000 in interest (excluding closing costs). Or she could pursue a 5/1 adjustable rate mortgage (ARM) at 3%--either way the homeowner will save cash.
In this scenario, the homeowner has a decent amount of equity in her home so she shouldn’t have to be concerned about the appraisal putting her in an “upside down” position (where your home is worth considerably less than what you owe).
While the homeowner could save a good chunk of change with the 15-year fixed mortgage she is already half way through paying off her existing loan (with half of her payments going directly to principal). While she will realize a savings with a new loan, she may add a few years of payments, especially if it’s amortized over 30 years.
On the other hand, if the homeowner could handle the aggressive structure of the five-year ARM, she could end up being very close to paying off the loan at the end of the five-year fixed interest time period. With a 5/1, the homeowner has a fixed rate during the first five years and then it is adjustable the final year.
The only gamble with the ARM is that you don’t know where interest rates will be in six years. Although rates could be much higher than what borrowers are used to seeing right now, the homeowner may not be significantly impacted since the majority of the loan has been paid off. When it comes to an adjustable rate mortgage, the deciding factor is whether the homeowner can pay off (or be close to paying off) the loan during the five-year time period or not.
What about the homeowner who desperately wants to refinance but is underwater in their mortgage loan? Until the recent emergence of HARP 2.0, homeowners who were deeply underwater had trouble refinancing. Homeowners like Matt Hamilton of Maitland, Florida who has been seeking refinancing for his underwater home may finally see relief.
Like many underwater borrowers, Hamilton has been paying his mortgage and playing by the rules, but unable to secure a new loan. “It’s been difficult because I'm so far in the hole that no one wants to refinance me," he said. "But if you look at my payment history, I am a safe risk."
HARP 2.0 provides a gateway to refinance as long as the borrower has a mortgage loan owned by Freddie Mac or Fannie Mae and has been consistently making on-time payments. The big difference with HARP 2.0 (versus the original program) is that an appraisal is no longer required--the one factor that disqualified numerous underwater borrowers in the past.
Travis BeMent, mortgage-loan originator for Home Loans Today of Orlando commented on HARP 2.0 by saying, "It's a reward for the responsible borrower who swallowed a bitter pill but still kept moving. There're a lot of people out there ready to pounce on this."
What is Your Personal Situation?
Another important consideration is your life stage. For a young couple starting a family, upgrading to a larger home may be the right decision, especially if they plan to live in the home for several years.
Although the breeding ground for upgrading is ripe for young homeowners, experts urge families to exercise caution. Jake Engle, financial planner at Wealth Planning & Management in Portland, Oregon says that young families should use their head and not their heart when they think about moving up.
“We’re sold this fiction that bigger is better and that two or three people need a 3,000-square-foot home,” he says. “And that’s deceptive. Banks will let you ruin your life by letting you get a house you can’t afford.”
Experts suggest that once borrowers have established how much home they can comfortably afford, they should take added costs like principal, interest, insurance, maintenance, utilities and taxes into consideration to obtain a clear picture of what they will be paying.
Mark Berg, president of Timothy Financial Counsel says that borrowers should keep the big picture in mind and remember that timing is everything.
For example, those who may be hoping to retire in the next 10 to 20 years (or even sooner), moving to a larger home may not be a great idea. Take a family of four with two kids in high school--the notion of spreading out and getting more space may seem attractive in the abstract. However, parents with older children will most likely (and hopefully) be empty nesters sooner than later.
Also, if the children are planning to attend college and you’d like to foot the bill, you may be looking at having to shell out a six figure yearly tuition. Even if your children qualify for scholarships and financial aid, you will most likely be paying a decent amount.
On average, college tuition runs about $60,000 (not including housing, books and spending money for pizza). Multiple that by two (if you plan to send both kids to college) and you are looking at least $120,000 per year in expenses. With retirement not far off in the horizon the homeowner should consider if now is the best time to make the move or if she should go back to refinance her existing home.
What’s Your Market Like?
While house hunters are able to get a great deal on a nice piece of property, homeowners continue to have a hard time selling their home for a profit. According to the Standard & Poor’s/Case-Shiller index released on November 29th, U.S. home prices have fallen in many major markets, which ultimately raises competition, making it difficult for many homeowners to make a profit off of their sale.
High unemployment and a soft job market may be to blame. David M. Blitzer, chairman of the S&P says that it doesn’t appear as if prices are going to increase any time soon.
"Any chance for a sustained recovery will probably need a stronger economy," he says.
Cities that saw the biggest decline in price included Atlanta, San Francisco and Tampa. However, some cities that demonstrated a slight increase were New York, Portland, OR and Washington.
Despite a market flooded with affordable property, consumers aren’t snatching up homes. Stan Humphries, chief economist at Zillow.com believes that consumers encounter problems because they aren’t qualifying for loans or cannot meet higher down payment requirements.
"Despite record high affordability of real estate, the psychology of home buyers is still being weighed down by economic uncertainty, keeping them on the fence when it comes to buying homes," he says.
However, not all reports point to down prices. Contrasting the S&P, the U.S. Federal Housing Finance Agency reported that prices actually rose in September and were down only slightly than a year ago. The agency’s index is calculated based on purchase prices of homes financed with mortgages that were sold or backed by Freddie Mac or Fannie Mae.
Additionally, on the heels of HARP 2.0 announcements, the number of underwater homes decreased moderately. CoreLogic reports that the number of underwater properties was 10.7 million (or 22.1% of all residential homes with a mortgage).