Jun 15, 2010

When is it Right to Refinance a Mortgage? (Carole)

First the disclaimer:  I am not an expert.  However, we have refinanced our mortgages a couple of times over the years and so I do have some experience with this subject.  At the end of this post, I'll link to some websites that explain things in much greater detail.

Here are the basics:

Pros of Refinancing your Mortgage:
1.  Lower your monthly payment
2.  Can shorten the length of your mortgage (changing from a 30 year loan to a 15 year loan)

Cons of Refinancing your Mortgage:
1.  You return to the BEGINNING of your mortgage cycle -- meaning that your are at Payment #1 again.
2.  Because you are on Payment #1 again, the portion of your monthly payment that goes toward paying the principle goes back to its smallest amount and your payment portion for interest goes back to its largest amount.
3.  The lender charges closing costs for lowering your interest rate.  You didn't think the bank was going to give you 10's of thousands of dollars for FREE, did you?  Expect to pay at least $2,000 in closing costs.  Obviously the more money you're borrowing, the higher your closing costs will be.
4.  There are many other fees (beyond closing costs) associated with refinancing.  To some degree, it is like you are buying your house all over again.  Remember how fun that was??  Taxes, insurance, and prorated insurance will most likely be due also.

Good Advice
Most experts agree that you need to be able to reduce your loan interest rate by at least 2.0% to make it worth all the fees you will be charged.

Don't refinance if you're selling the house soon.  Go to Bankrate refinancing calculator and see how much your monthly payment will be with your new loan.  Subtract that from your current monthly payment and see HOW MANY months it will take you to save the money you will have spent on closing costs, fees and taxes from your refinance.  Will you own your house long enough to make up this $ difference?

Be careful with ARMs (Adjustable Rate Mortgages) right now.  Home loan interest rates are currently so low, that the chances that your mortgage payment will adjust up in a year or two are very good.  With the economy where it is, this could be dangerous for your financial future.

If you do refinance, go for a shorter length mortgage:  15 year instead of 30.  You will save 10's of thousands of dollars over the life of your loan with just this one change.

Further reading:
Noodling Over a Mortgage Refinance
When is it Right to Refinance Your Mortgage?
Refinancing Basics 


Jess said...

One comment on the 15 vs. 30 year thing: we asked our mortgage broker for a 15-year mortgage when we were buying our house last year, and he told us that while he was willing to do it, there was really no advantage to it at the moment, interest rate-wise. One advantage of a 15-year mortgage at some points is that you can get a lower interest rate on them, but with rates so low right now in general, you can usually get a similar, if not identical, rate on a 30-year mortgage.

So, what we opted to do was take a 30-year mortgage, calculate how much extra we needed to pay each month to pay it off in 15 years, and pay slightly more than that amount each month. This way we are still paying our mortgage off at a 15-year pace, on track to save the tens of thousands of dollars you mention, but we have the flexibility of a lower minimum payment if we ever hit financial catastrophe.

Of course some people might not be able to force themselves to pay the extra each month if it's not absolutely required, but if you think you can stick to the self-imposed higher payment plan, this strategy is one worth considering.

Jess said...

Oh and also, if you do what we did, it's crucial to verify that there is no early payment penalty attached to the mortgage. Otherwise when you pay your mortgage off at the end of 15 years you could end up with some pretty nasty fees.

Carole said...

Great comments, Jess! Thanks for adding them.

G said...

We got told the same things as Jess when we bought our house. But recently we were able to refinance with NO closing costs. Our payment is significantly lower, so our only drawback is the fact that our loan "started over." However, we are just continuing to pay the same as we used to pay, which will quickly compensate for the "starting over." Like Jess said, now we just have a safety net of being able to pay less if the need arises due to crisis of some kind.

Sara said...

Hey Carol,

I agree with what you've written regarding refinancing a mortgage. With the rates going quite low, it is a good time to refinance a home loan provided the borrower has equity in his or her property. However, when a borrower refinances a 30 year mortgage into a 15 year loan, the mortgage payments generally get increased as the term of the loan gets shorter. Thus, unless the borrower can afford the higher payments, its better not to refinance the 30 year mortgage into a 15 year loan.

Take care,