You may be looking for some cash if you overdid the holiday spending. Many people are taking advantage of refinancing during this long stretch of low mortgage rates. An interest rate that lowers your monthly payment and how much you ultimately pay for your home is a good reason to refinance and there are several other reasons you should consider this. Although interest rates have been mostly steady lately, no one can say where they will be in 3 months, 6 months, or a year from now. Rates could drop next week or they could raise well above historic lows for the next decade. You should evaluate whether to refinance a mortgage based on your current situation and today's rates, not a prediction of future rates.
Your mortgage isn’t the only loan that you should consider refinancing. You can also put more money in your pocket every month by refinancing student loans, credit cards, and any other loans. However, your mortgage is probably your largest loan and will save you the most money under certain circumstances. The primary considerations before refinancing are:
Reducing your interest rate is only one consideration. Everything else being equal, an interest reduction from 5.0% to 3.9% on a $175,000 mortgage amortized for 30 years will save you $114 per month or $1,368 per year. But it’s not that simple. You need to factor in other variables. If you’ve already paid off 10 years of the loan and refinance for another 30 years you will ultimately pay a total of $299,151 (principle and interest only). However, if you pay off the remaining 20 years on the current loan you will pay a total of $277,181 ($19,970 less). This is a function of the amount of time required to repay the loan. On the other hand, if you refinance the same loan at 3.9% but reduce the amortization schedule to 20 years, your monthly payment increases to $1,051 but ultimately your total cost is lowered to $252,304. Time and money are intimately related. Inflation is another time/money relationship to consider. As your income increases in the future, the dollars you pay towards your mortgage are worth less. If your only goal is a lower monthly payment, go with the lower interest rate amortized over another 30 years. If your concern is your total cost, you have much more to think about including the cost of refinancing.
Cost of refinancing. The mortgage industry is aggressive and competitive which can be a good thing. But when you are offered no-cost refinancing, be very wary. Read the fine print carefully and ask plenty of questions because there are costs involved and these have to be paid for somehow. They could be rolled into the total loan which means you’re borrowing and paying interest on more than just your outstanding balance. Or these could be recovered as a higher than average interest rate. Charges and fees vary by location and lender and are negotiable. Typically included are mortgage application fee, appraisal, loan origination fee, documents preparation fee, title search fee, recording fee, flood certification, inspection fee, attorney fee, and survey fee. These fees often cost between $2,000 and $5,000.
Stop paying PMI. If your existing loan was originally for more than 80% of the appraised value, you’re almost certainly paying PMI in your monthly payment. You can stop paying PMI once you own 20% or more of the equity in the home. This doesn’t mean paying off 20% of the loan. The appreciated value counts. If you’ve owned the home for 5 years and it appreciated in value 5% each year (plus your monthly loan payments), you now own well over 20% equity in the home. The mortgage balance date when you will owe less than 80 percent of the original value of your home should have been given to you in writing on a PMI disclosure form when you received your mortgage. But don’t assume your lender will automatically stop collecting the payment. If you decide to keep your existing loan, send a written request that your lender stop collecting PMI. Be aware there are other conditions such as if you are current on your payments. If you refinance for less than 80% of the home value, be sure PMI is not included in your new monthly payments.
When NOT to refinance. Refinancing into a lower interest rate mortgage can indeed be a good move that puts more money in your pocket – but not always. Be sure you have the full picture before making the decision. Use the Refinance Mortgage Calculator to run various scenarios to help you make a decision.. Low interest rates can potentially save you big bucks but it’s not always the right decision. If you are planning to move or sell in the future, you need to calculate the breakeven point to determine if you’ll save anything. Another time is when your credit score is too low for you to obtain a better interest rate. Waiting until your credit score improves even just a few points could make a big difference. Taking out a home equity loan can be appealing when you are struggling with other debts that you are considering consolidating. If you’re already struggling with debt, increasing your monthly mortgage payment could put all of your equity at risk if you fall behind on the payments.
Refinancing into a lower interest rate mortgage can indeed be a good move that puts more money in your pocket - but not always. Be sure you have the full picture before making the decision. Also, our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions, inquiries, or article ideas to [email protected].