Mortgage rates are now the lowest level we’ve seen in the last 17 months ago. If you can save money by refinancing your mortgage or have been putting it off, you owe yourself to explore your options. Here’s the five setbacks to know before pulling the trigger…
The 1% Rate Reduction Rule
Most finance experts recommend you should not refinance your house unless you can save 1% or more in interest rate. This school of thought might make sense for the broader masses, however its not the optimal one size fits all approach. Many can still benefit by refinancing their house for less than 1% reduction in their interest rate. Consider these other factors that play a role in determining whether refinancing really is beneficial:
- PMI-private mortgage insurance, if you have this fixed expense built your mortgage payment, dropping this cost via refinancing with a less than 1% in rate reduction can amplify the monthly payment savings.
- Lower Financed loan amount-how much lower your loan amount is now in relationship to your original loan amount also is a factor. Financing any amount lower than your original loan amount with a lower rate will support monthly savings.
- Loan term-this one is a biggie. The spreading interest rate on 15 year versus 30 year loans presently is approximately 3/4 of a percent. Consider the following example, if you have a 30 year fixed rate loan figure you are two years into a say 4.25%, and you know you can afford a higher mortgage payment, switching to a 15 year mortgage at 3.5% knowing the loan will be paid off in 180 months, very well could make financial sense depending on your income and equity objectives.
Starting The Clock Over
This is probably the number one concern before signing off on refinancing. Here’s why: when you take out a fixed rate mortgage, the loan is based on an amortization schedule so the loan is paid off in full with interest based on whatever terms the loan is set for i.e. 180 months or 360 months for example. Each time you refinance your home, the clock does start over on a new loan term. Say you’re paying a 5.0% rate on a mortgage you are fivers years into assuming a 30 year fixed. Why refinance to start over for 30 years for a lower rate say at 4% when it will take you five years longer to pay it off? This is the classic homeowner example many consumers pose to avoid throwing good money after bad.
The key-make the same payment on the loan being paying off on the new loan that you are taking out. Doing this, prevents the clock from starting over while saving substantially in the interest over time, compared to the higher rate loan being refinanced away. The difference in the payment savings generated by the refinance goes directly to principal in this strategy and in doing so, more equity will accumulate over time.
Breaking Even On Refinance Fees
The most common way to do this would be to take the monthly payment savings generated by refinancing and divide that figure into the closing costs (capital) required to complete the loan.
For example if closing costs to refinance are $2,700 in exchange for saving $200 per month, that’s a snazzy 13.5 month recapture. Generally, if you can break even in two to three years by refinancing, that’s a healthy way to measure the loan opportunity.
This is accomplished by taking an interest rate slightly above ‘current market’ in exchange for the lender providing you a credit below, equal to, or above the amount of your closing costs. Doing this can easily pencil, if you can avoid the fees and still reduce your rate. Say you have a 4.375% 30 year fixed rate mortgage and your lender can do a refinance for you reducing your interest rate from 4.375% to 4.0% and you don’t pay any of the closing costs, and you attain a lower interest ratein the process, that is a win-win situation.
“I just just stay with my current loan because a xyz years into my loan, despite my rate being above market. I will just start making an extra principal prepayment each month, that way I don’t have to pay the closing costs and growth through the refinance process.” If you cannot qualify for a mortgage, then yes, this is a viable action in continuing to chip away at your loan balance. However, if you can qualify, it would be dramatically faster for you to pay off your house sooner with a lower interest rate, than higher one, and the additional savings created by the refinance, coupled with your fastidiousness in already making a principal balance monthly prepayment, will compound your paydown efforts, effectively, enhancing the speed at which your balance will drop. If you can reduce your interest rate in this scenario on a no-cost mortgage or a measurable short term refi recapture mortgage, math usually pencils in favor of the consumer.
Researching refinance options? Get the clarity and details you deserve with a free mortgage rate quote from Scott!