There is a lot of hype about refinancing your mortgage and you’ll often hear statements like, “Rates have never been lower!” The truth is, interest rates are low right now (and Ben Bernanke stated in late June that he expects they’ll stay low for a while). However, even when they’re at their lowest, refinancing depends on your personal situation. While it’s important to talk to a mortgage expert (preferably not the person/institution who would be doing the refinancing for you, as they stand to profit from how they answer your questions), there are several factors you should take into consideration to help you decide if you’re ready to refinance.
Up-front Mortgage Advice
For my clients who have large amounts of money in a taxable account, I typically recommend that they look into paying a lump sum toward their mortgage. Many investment advisors won’t recommend this because it lowers the investment amount they are managing for their clients, which in turn lowers the amount they are paid in fees. However, I believe in improving the client’s whole financial picture, and will typically recommend that you pay more toward your mortgage each month if you have the income to do so. Just paying an extra $100 a month can drastically reduce the amount you pay in interest over the life of a 30-year mortgage.
Performing a Break-Even Analysis
Refinancing your home only makes sense if you can lower your interest rate enough to pay for the closing costs before you sell your home. For example, if you are currently holding a $200,000 mortgage and you can lower your interest by 1% when you refinance, you’ll save $2,000 a year. If your closing costs are around $4,000 it will take you 2 years to break-even on your refinance. Typically, refinancing is worth it if you’re able to lower your rate by at least 2%. That seems to be the point where people see real savings on their monthly payment.
Points, ARMs, and Seconds
Often times, it is not as simple as just deciding whether or not you break-even. You really need to know what to ask for when speaking with the mortgage company to be sure you don’t pay fees that are unnecessary. After all, holding your mortgage is appealing to banks and they should feel like they’re vying for your business. When gathering your quotes, be sure to ask for a “zero quote” or “par quote.” In those cases, closing cost estimates will not include origination fees or points. Be up-front about the fact that you won’t pay these fees. They are simply pre-paid interest, and any savings you may see will not justify the up-front expense.
If you currently have an Adjustable Rate Mortgage (ARM), I almost always recommend that my clients look at refinancing into a Fixed-Rate Mortgage. Often times, writing the check up front to pay for closing costs is worth it to avoid the risk that your payment will increase when rates adjust. It may also save you money in the long-run if this happens. In my experience, people seem to always believe they can get into an ARM and refinance before it adjusts. However, Murphy’s Law tells us that something can, and will, often arise that will prevent you from doing this.
Some of you have second mortgages, and you may think that rolling it into your first mortgage in a refinance is the way to go. However, I recommend that people evaluate something first: If the balance of your second mortgage is less than half your annual income, pay it off in your debt snowball. If it’s larger than that, then you can wait to pay it off until after you have established retirement accounts and college funds for any children you may have.
Should you move from a 30-year to a 15-year in a refinance?
If you aren’t able to pay cash for your home when you purchase it, it is best to get no more than a 15-year mortgage. If you already have a 30-year mortgage and your rates are low enough, do not refinance just to get the shorter term. You will save just as much money in the long run by calculating the 15-year term and paying that each month on your 30-year mortgage.
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John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit https://www.chladekwealth.com.