Interest rates on mortgages are at all time lows; does that mean you should refinance as soon as possible?
Maybe–and maybe not.
Interest rates may be lower than they’ve ever been, but never has the issue of refinancing been more complicated. For one thing, it’s harder than ever to qualify for a loan at the best rates, and for another, today we have to consider falling property values which is something that hasn’t existed since the Great Depression.
What are the pros and cons to refinancing your mortgage?
The reasons you SHOULD refinance – Pro
If your credit and income situation are strong enough, and your home has sufficient equity, there are several tangible benefits to refinancing your mortgage.
Lower house payment.
The most obvious reason to refinance is to lower your house payment. Not only will that make your payment easier to handle, but it can free up money for savings and investment creating a double-win situation.
Lower interest rate.
While this may seem part and parcel of a lower house payment, it has advantages all its own. The lower your interest rate, the less of your payment will be devoted to interest expense and more will go toward principal. This will mean faster equity build up and create an opportunity to pay off the loan early.
[Related: Check out mortgage refinance rates in your area.]
Shorter term/faster payoff.
Not all refinances are designed to lower your monthly payment. Some are set up to lessen the loan term to enable the mortgage to be paid off sooner.
If you have a 30 year loan with 25 years remaining, and you refinance to a 15 year loan, you will move the payoff of the loan up by 10 years. If the rate drop from the 30 year loan to the 15 is large enough, you may even be able to do this without increasing the monthly payment—another example of a double-win!
Staying ahead of house price declines.
This is something no one thought much about until a few years, but now it’s something that can’t be ignored.
In many markets, house prices have been declining steadily, and one of the best ways to deal with this is by accelerating the pay down and eventual payoff of your mortgage. If a refinance helps you to do this, then it’s a step well worth taking by itself.
The reasons you SHOULDN’T refinance – Con
As compelling as the benefits of refinancing are, there are some reasons why doing one may not work for you, or why you may not even be able to.
Closing costs.
Refinances aren’t free, even if they result in lower rates and monthly payments.
Those benefits are paid for through closing costs—origination points, appraisal fees, legal and title fees, insurance and taxes among them. Collectively those charges can (and usually do) add up to thousands of dollars. They can be paid for in a variety of ways: out of pocket, adding them to the new loan balance or lender paid through a higher loan rate, but each will lower the benefit of the refinance in some way or another.
Recasting and extending the loan term.
Often the greatest savings on a refinance comes from extending the term of a loan.
For example, when you refinance a 30 year loan with 25 years on it back to a new 30 year loan, you’ll lower your monthly payment, but you’ll also add five years to the payoff. That will help to keep the monthly payment affordable, but it will extend the term of the loan when it does. You may find that adding five years worth of payments to the back end of the loan doesn’t justify the savings on the monthly payment.
Moral of the story: if you refinance your mortgage, make sure the new loan doesn’t exceed the number of years remaining on the current one. A loan with 25 years remaining should be refinanced to a loan no greater than 25 years.
You will only get the best rate if your credit is excellent.
In order to get the mortgage rates you see advertised you’ll have to have excellent credit, a sufficient income (with a steady history of earning it), plus “reserves”—money left over after closing in an amount equal to several months of your house payment.
A lot of people don’t have this kind of profile after the job losses of the past few years, and if you’re one of them, you won’t get the advertised rates.
Your property may not have sufficient value.
If your home has declined in value faster than your mortgage has, you may not have enough equity to get the best loan rates—or even any loan at all.
Finally
If you can get all of the above working in your favor, a refinance can be a real step forward in your financial plans. Just make sure that what it is your doing will be a true benefit, and not a matter of rearranging the numbers to make it seem as if there’s an advantage.
Excellent summary of the pros and the cons. I’ve had several conversations with clients who are seduced by a lower rate, but when we looked at the whole picture realized they were better off sticking with their current loan.
“Seduced by a lower rate…” – great way of putting it. A low rate isn’t the whole picture at all is it?
A lot of great points here Craig. I agree 100% you say it will extend the life of your mortgage by refinancing. This is why I often suggest to people if you are going to refinance go to a lower term mortgage such as a 15 or 20 year mortgage.
This way if you are only 5 years in on your mortgage you might be able to cut an additional 5 to 10 years off and even keep the same payment in a lot of cases.
I think a lot of people don’t realize that they are starting at year zero when they refi to another 30. You have to pay attention to that.
We recently refinanced our 30 but we were less than 2 years into our mortgage and with the lower rate we can pay more towards principal to make the term shorter (pre-paying the loan).
I would never extend the period of my loan or cash out any equity but I know a ton of people that would. Refinancing isn’t really an option for me because my mortgage balance is less than 100,000 and closing costs would eat me alive. If you have a higher balance it can save you a ton for sure.
A lot of people see that low rate and payment an see how much less they are paying rather than thinking about how much more they can pay towards their mortgage (or other places you can invest the money).
There are some who truly need the lower payment to make ends meet though, which is why you have to take a lot of things into consideration.
Very good summary. I held off for a long time because I thought the lack of equity I had in my house since purchase would disqualify me from getting the best rate or getting PMI. Turns out I was able to qualify even if my equity was low as long as I used the original lender. At least that’s what they told me. Not sure if it was true, but in any case, it did save me a ton of money, it’ll lop off about $70k in interest over the life of the loan. And I refinanced to a 15-year mortgage from the original 30 (which had 26 years left) so I cut 11 years of payments out as well.
Glad to hear you were able to refi and that it will save you a good amount of money.
“If you have a 30 year loan with 25 years remaining, and you refinance to a 15 year loan, you will move the payoff of the loan up by 10 years. If the rate drop from the 30 year loan to the 15 is large enough, you may even be able to do this without increasing the monthly payment—another example of a double-win!”
We recently did this exact thing on our home and two different rental properties. In my opinion, this is the best and really only reason to refinance. If you are planning on refinancing to another 30-year loan, all you are doing is extending the period of time you are in debt. Yuck!
Another thing that I would caution people against is refinancing to lower your payment…then going out and spending that “saved” money on another sort of payment. We persuaded a relative to refinance a few months ago, hoping that they would refi to a 15-year instead of 30-year and pocket their savings. Instead, they refinanced to another 30-year loan and spent the extra savings by financing a new motorcycle and flooring. All they really did was increase their debt and extend the amount of time they will be paying that debt off. I guess they’ll own their home about the time they turn 70.
Oh well. I guess you can lead a horse to water, but you can’t make him drink.
I think you should definitely have a real plan for what you are going to do with the extra money if you are going to have a lower payment.
And you’re right about the horse.
Great breakdown of the pros and cons. I’m considering refinancing next year if the rates are still ridiculously low.
Thanks. Relatively, even if the rates go up some they will still be very near historic lows.
What we all forget about is that it’s not cheap. You can spend thousands of dollars on the closing costs. Will you still be ahead after this money is spent? It’s your job to run those numbers.
Good point. For some people it can take 2 years before the benefits outweigh the costs in a refinance. It depends on the loan and the costs though, but it certainly a factor you have to be aware of.
The historically low rates definitely make it one of the best times ever to refinance, but the numbers have to work. This was a really good list of how a refi can work or not work for your situation.
It’s definitely best to sit down, run the numbers with someone who knows what they’re doing, and figure out if refinancing will benefit you or not in the long run.
I wrote an article not long ago about refinancing that may be of interest: http://www.cfinancialfreedom.com/CFFwordpress/should-i-refinance-now/
Yes, and watch who you are running the numbers with too. Just like with initial mortgages I’m sure there are banks and such out there that will tell you what you want to hear rather than the objective facts.
I would also recommend checking the cross over point (not sure if this is a pro or con vs. just quantifying your pros/cons). There are a few calculators out there but my favorite one is on dinkytown
crossdresser brisbane is great web platform for your own free sexy chat experience