- It's no surprise that many people are looking to refinance their mortgages while interest rates are at historic lows, and I'm happy to help with that process as long as we can check a few boxes.
- If your monthly payment will drop and you'll pay less interest over the life of the loan, refinancing may make sense.
- I also look to see how a new payoff date will impact your retirement plans, and if you might be wise to switch to a 15-year mortgage.
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With mortgage interest rates at all-time lows, you may be wondering whether it makes sense to refinance. In addition to thinking through the impact of refinancing on your monthly payment and overall cost, there are some other timely factors to consider right now.
Let's start with the not-so-great news. According to Jeff Bochsler, senior vice president of lending at Guaranteed Rate, Freddie Mac and Fannie Mae are bumping up the cost of refinancing by 0.5% starting on December 1, 2020.
Borrowers will either pay this fee upfront or see a higher interest rate, typically 0.125%, on their new mortgage. Lenders will be pricing this extra fee into their rates in the coming weeks, so if you are looking to refinance, it could be wise to lock in a rate now so that you can close before December 1 and avoid the higher fee.
Now for some good news: The Federal Reserve adjusted its policy on inflation targeting last week, which means that it is more likely to let interest rates remain low even if inflation starts to creep up.
And given that the long-term average interest rate on a 30-year mortgage is about 8%, I couldn't be happier to be helping clients lock in at 3% or lower, as long as we can check a few boxes.
Here are the parameters I'm using to help clients decide whether refinancing their mortgages makes sense for them right now.
Determine how your payment will change
For most clients, refinancing a fixed-rate, 30-year mortgage with a new 30-year mortgage at a lower rate will reduce their monthly payment. And for clients with an adjustable-rate mortgage (ARM), many of them can lock in a 30-year loan without increasing their payment. If your new payments will be lower than your current payments, we can check this box.
Determine how long it will take to recoup the cost of refinancing
Refinancing often comes at a cost, so it's important to evaluate how long it will take to recoup the cost.
Let's say you can refinance and lower your monthly payment by $100. However, refinancing will cost you $2,000 out of pocket. To figure out how long it will take you to recoup your cost, we can divide the $2,000 cost by the amount you'll save each month ($100). This tells me that it would take 20 months for you to recoup your costs. As long as you're planning to stay in your home for more than 20 months, we can check this box, too.
Figure out whether you'll pay more in interest over the life of the loan by refinancing
On the surface, lowering your interest rate seems like it would lower the amount of interest you'll pay, too. But that's not always the case.
If you're currently 10 years into a 30-year mortgage, you've already paid quite a bit of interest on your loan, so refinancing and starting your interest clock over again for another 30 years, even at a lower interest rate, might actually cost you more over time.
The longer you've had your current loan, the more likely it is that refinancing might not actually make sense for you. A mortgage broker or financial planner can help you figure this one out. Or if you're a do-it-yourselfer, a good online mortgage calculator can help you compare the interest left on your current loan and the interest you'd pay on a new loan.
Determine how refinancing will impact your final payoff date
Refinancing means restarting a 30-year clock on your mortgage, which means extending the time until you make that final payment. For clients who can still pay off their mortgage before retirement, this isn't a big concern. But for clients who would be forcing mortgage payments into their retirement years, refinancing may not be the best option.
Decide whether refinancing and making extra payments is the right option
Given that two of the primary risks of refinancing are extending your final payoff date and paying more interest over time, you might want to consider refinancing, but continuing to make the same payments you make now.
For example, if refinancing decreases your payment from $2,750/month to $2,500/month, what would the numbers look like if you continued to pay $2,750/month by making an extra principal payment of $250/month? In many cases, this is an excellent option that enables you to take advantage of lower rates, pay less interest over time, pay off your mortgage sooner, and have the flexibility to make a lower payment if needed.
Figure out whether switching to a 15-year mortgage makes sense
For some clients who can afford a larger mortgage payment and still be on track for their other financial goals, switching to a 15-year mortgage has been a great option given that 15-year rates have dropped below 2.5%.
If you're already working with a financial planner, reach out and ask them to help you determine whether refinancing makes sense for you given your overall financial situation.
Natalie Taylor, CFP, BFA, draws on 15 years of financial planning experience, seven years in fintech, and a decade of professional speaking to share advice that works in real life.
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