Congratulations to me! (…and Mrs. Super Saving Tips, too). After seeing and hearing a year’s worth of promotions about mortgage refinancing and the all-time low interest rates, we finally took the plunge.
When homeowners are bombarded with news about “record low rates”, they often have one thought on their mind: “Is this the time to refinance?” I guess that I have asked myself that question many times over my lifetime and each time I wavier and hesitate until it becomes really crystal clear to me. This time is one of those times! Right now, I have to say that refinancing for almost everyone is on paper at least, really a no-brainer!
“Why now, Gary?”
With rates as low as they are right now, I finally decided to pull the trigger and closed on my new (now just 15-year) fixed rate mortgage at just 2.375% and there are reasons why you should be looking at doing it, too, before things start to go in another direction. Let me explain.
I consider myself to be on top of things like mortgage rates and I originally closed on my current home about nine years ago at what then was a good rate of 4.75%. That rate was for a 30-year fixed mortgage and truthfully my only regret was the term, 30 years. You can do the same math I can and when I realized that I would be a facing a mortgage payment until I reached age 92 (yikes!), it was very depressing. Mortgages come in two parts you need to consider: the interest rate of course and the term (years) you have to pay it off.
Mortgage Refinancing Means Paying Off an Existing Loan
Paying off your old loan and replacing it with a new one is done for many reasons. So why do homeowners refinance?
- To obtain a lower interest rate
- To shorten the term of their mortgage
- To convert from an adjustable-rate mortgage (ARM) to a fixed rate mortgage, or vice versa
- To tap into home equity for funds
Since refinancing can cost between 2% and 5% of a loan’s principal and as with an original mortgage, requires an appraisal, title search, and application fees, it’s important for a homeowner to determine whether refinancing is a wise financial move.
Lower Interest Rates Are Just One of the Factors
Lower rates means you pay less in interest, saving tens of thousands of dollars over the life of the loan. Frankly, when I took a hard look at the rates I saw that I could cut my rate in half. Doing that would save me money but still left me with questions.
The questions and answers aren’t always obvious, and like everything when it comes to personal finance, it depends on your specific circumstances. It’s like a puzzle: there are pieces of it you must consider and you have to fit them together to look at the whole picture. That’s why you have to ask yourself questions like these:
1. Is my current mortgage rate too high?
This is subjective, of course. For those unlucky enough to get a mortgage in the 80s, rates got as high as 18.63%. Yes, I lived through that one myself!
That is clearly a horrifically high mortgage rate, and if your rate is in the double digits then the answer is yes, the rate is too high and you should refinance. What about those homeowners who bought their home in 2007 and got a rate of 6.34%? This is more than double the rates offered now, so this rate would be considered high today. However, the answer is not as obvious for most. What if your rate is 4.5%? Should you refinance? This requires some math.
2. Will I qualify for a better rate?
Before you do anything, make sure you can get one of these great low rates. To take advantage of today’s low rates you will need, among other things, to have an appropriate source of income and a good credit score.
This is why I have spent my lifetime trying to build my credit score because it so often is a key factor on major life changing events like owning a home and the cost. But if you do have the score needed, there’s also the fact that you need to “shop around” and get rate quotes from the many lenders out there who are breaking their necks trying to get as many new clients as they can! They all are different.
3. What will my savings really be at a lower rate?
Let’s say 12 years ago you bought a home for $220K, and after your $44k down payment (to avoid PMI), you were left with a 30-year, $180K mortgage loan at a rate of 4.5%. Today, you are approved for a 3% rate for 30 years. Using a simple mortgage calculator, you can calculate the following (not including taxes and insurance):
Current mortgage payments at 4.5% = $890 per month
Refinanced loan at 3% = $590 per month
Savings = $300 per month
So, is this a no-brainer? You’re saving money each month, and in many situations this is enough to justify refinancing. But, there’s more to consider.
4. What are my closing costs?
Since you’ve already bought a home, you’re familiar with closing costs. Typical fees include application fees, loan origination fees, appraisal fees, and other (sometimes optional) expenses. What some may not know is that you have to pay most of those same costs when refinancing your home. While there’s no standard way to calculate, you can generally plan on paying about 2% to 5% of the refinanced amount in closing costs.
National average closing costs for a refinance are $5,749 including taxes and $3,339 without taxes, according to the latest data from ClosingCorp, a real estate data and technology firm. With the example I used, the closing costs are about $3,900.
5. How long do you plan to stay in your home after refinancing?
This is where closing costs really matter and the answer is critical. You have to have an idea of how long you’ll be in this house to understand if you will save or lose money by refinancing.
This is referred to as your breakeven point.
The breakeven point in refinancing is the amount of time it will take for you to recover the closing costs considering the amount you’re saving. There are several components to consider, such as how much is going towards principal vs. interest. This is where a refinance calculator comes in handy, but you can use some crude math to give you an idea.
In our example here, if you moved one year after refinancing, you would save $3,600 in payments ($300 savings x 12 months). But you paid $3,900 in closing costs. In this case, you are not saving enough money to justify refinancing, and in fact would end up losing money. An actual refinance calculator that includes all factors would show your breakeven point is 13 months.
Financially speaking, it only makes sense to refinance on this case if you are planning to stay in your home for 13 months or longer. In addition, in my example you will be extending your mortgage an additional 12 years so consider that fact as well.
My Bottom Line
The main reason I chose to refinance now was both the reduced rates and the shortening of my term on the mortgage that both really work for us. At this point of my old mortgage, I still had about 21 years remaining before it ended. With the new great lower rate I qualified for, even with the closing costs (which actually can be folded into the mortgage and not a single penny is out of pocket), a new 15-year mortgage would shorten the term by six years and overall save me over $30,000 by taking six years off my debt. Ok, so I’ll be 86 when the mortgage ends, but at least I’m trending in the right direction!
You’re going to keep on seeing and hearing about refinancing your mortgage for the foreseeable future. No one really knows when the rates may start their inevitable climb back on the upward trend that has been the case for every financial cycle ever. One thing for sure is that these rates are currently so low that the bottom is pretty much in sight. At rates like 2.375% for a mortgage refinance rate (more or less depending on your circumstances), just exactly how much lower can they go?
Is mortgage refinancing a good idea for you? Have you looked at your options and can you see how you can save money now and for years to come? If you are not a homeowner now and want to be, mortgage rates may still be calling your name if you can qualify for the best rates ever with your good credit.