Interest rates for 30-year fixed rate mortgages have averaged under 3% over the last few weeks. The Fed’s response to the pandemic has propelled these rates to never-before-seen lows and assisted in creating a hot housing market across the country. But what if you already own a house? Is it time to call your mortgage broker to refinance?
Why are you doing it?
Before you make that call, consider both the reasons you want to refinance and the amount of time you have left on your current mortgage.
Shorten the mortgage term. Refinancing to pay off your mortgage quicker can save you thousands. For instance, the total interest on a 30-year $250,000 loan at 4% ($179,674) is much more than the interest you’ll pay on a 15-year loan at the current rate of 2.5% ($50,055).
Lower your interest rate. Even if you decide to stay with a 30-year mortgage, reducing the rate you’re paying can provide outsized benefits. Using the example above, if you went from a 4% rate to a 2.9% rate your total interest would decrease by more than $55,000 ($179,674 – $124,607).
Moving from expiring ARM to fixed rate. Adjustable rate mortgages normally provide lower interest rates initially than fixed rate loans. But you can end up with an ARM charging a higher interest rate several years after the fixed-rate period has ended. Plus there are balloon ARMs where at the end of a specified period, you are expected to come up with a large amount to pay off the mortgage. Refinancing into a fixed product, especially a 15-year loan, can even out your payments and save you money in the long run.
How long will it take for you to see the savings?
One key to refinancing is to figure out the break-even point, the point at which your costs for the refi are recouped by the savings you’ll see from the lower interest rate. Let’s use our $250,000 example above with a 30-year mortgage, where you’re moving from a 4% fixed to a 3% fixed and assume the costs to refi are $2,500. Not including escrow (taxes and insurance), your monthly payment for the 4% loan would be $1,194, while the payment for the 3% loan would come in at $1,054, a savings of $140 per month. Simply take the total refi costs and divide by the monthly savings amount. With this example, you would break even in a little under 18 months, after which you would see the savings from the refi.
Obviously, if you are planning to move in a year, doing the above refi would be a waste of money. Before you sign any paperwork, make sure you have determined the break-even point and know that you will be in the house for that duration.
Note – interest and payments calculated using the Bankrate.com Amortization Schedule Calculator.
How long is the process?
While you will need to provide volumes of paperwork, the refi process has become more streamlined. I once refinanced our house completely online, never meeting in person to sign documents. Often companies that specialize in refinancing mortgages have better turn-around times, some as short as a couple of weeks (most average 30 days). However, just like a regular mortgage, call at least three different companies and compare their rates, fees, and processes. When interest rates are low – like now – one question to ask is how busy they are and how it’s affecting their time to close.
Beware Refi Traps
This may sound like a no-lose proposition, and for many people it is. However, there are circumstances you must watch out for.
No-fee refi. Like the financial articles say, there’s no such thing as a free lunch. Lots of refi companies advertise no-fee mortgages. But there are fees that must be paid, so it comes down to how you want to pay them. You can pull money out of your checking/savings account and pay them outright. The refi company can wrap the costs into the loan and increase the amount you’re borrowing. Or you can get charged a higher interest rate.
This is why comparing options is so important. Some companies in your area may be able to tuck the fees back into the interest rate you’re quoted and still be competitive. The only way you’ll know is to consider at least three firms, making sure to find out what the different rates are if you pay the fees outright or they roll them into the interest rate calculation.
Cash-out refi. A cash-out refinance occurs after you’ve built up equity in your home or the home’s worth has increased. Maybe you bought your home several years ago and now owe $140,0000 on the mortgage. The market has exploded and your house is now worth $250,000, meaning you have $110,000 in equity. Some people choose to pull a percentage of that money out when they refinance.
If you are doing a cash-out refi to improve your house – perhaps by redoing the kitchen or adding another bedroom – or to buy another appreciating asset, most experts agree the cash-out can be a good idea if you aren’t going overboard or pricing the house out of the neighborhood.
However, many people use the cash to take a vacation, buy a car, or pay off credit cards. And too often, the high credit cards will soon again reach the same heights, and suddenly you don’t have the extra equity in your house. Or the trip to Tahiti is over and all you have are the photos.
Refinancing every time rates move down. Remember the break-even point? If you start refinancing every time rates go down half a point, you may never pay off the first refi before you’re on to the second. While saying you have a 2.9% loan may be great at parties, make sure the finances work for you.
Total interest paid. When you start paying on a mortgage, you pay more in interest over the first part of your loan, then less as you go on (principal increases). If you have ten years left on the loan and you refi for 30 more, will you end up paying more interest in the long run than you would just staying with the current loan?
Refinancing can be a great way to reduce your payments and decrease the term of your loan, saving you thousands. If you are in your forever home, a well-planned refi can result in huge dividends. But make sure you run the numbers and get the best terms for your specific situation.
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