Everyone and their grandma seems to be talking about re-financing their mortgage these days. With interest rates still near historic lows (and many of us still suffering post-recession), what’s not to like about lowering your interest rate, monthly payment – or both? Not so fast there, cowboy. There are a few things to consider before you wander off into the re-financing sunset, so hold your horses and consider these key points first:
Housing Prices and Interest Rates Are Rising
Sure, interest rates are still about as low as we can expect. (As of June 12, Bankrate.com notes a 4.14% rate on a 30-year fixed mortgage, for example.) But this is already about 20% higher than the 3.5% rate available just over a month ago! And all signs are pointing to a continued economic recovery, so the money’s on more of a rise in the coming months and years. Housing prices, too, are increasing, also adding to the upward pressure through a number of mechanisms – and making it more likely that banks will offer you a loan. If you’re going to re-finance, now’s the time.
Many Adjustable-Rate Mortgages Can be Switched
As a corollary to the above, rising rates mean you might end up making higher payments soon — if you aren’t already. Locking in a fixed-rate mortgage may not sound as sexy as the prospect of ultra-low rates on an adjustable option, but again, the money’s on rates going up, not down. Plus, fixed-rate mortgages have other advantages – such as giving you the ability to budget and plan for the future more easily, since you’ll know exactly what you’ll owe on a monthly basis. As an alternative, you might be consider switching to an ARM with more favorable terms, such as a lower starting interest rate or a cap on payments.
Consider Costs and Fees
A typical re-financing bears costs and fees of about 3-6% of your outstanding principal, so for re-financing to make sense, you’d have to believe the savings will be larger than the expenses. These fees can include appraisal, application, and loan origination fees, amongst others, and they really add up. Bankrate.com offers a mortgage refinancing savings calculator that can help answer whether re-financing will even save you money. In some cases, you’d save more money by just making additional monthly payments toward the principal, instead, so check the Fed’s resources for home owners to do your own comparison.
When You Shouldn’t Re-Finance –And an Alternative Option
There are a number of cases when you shouldn’t — or simply can’t re-finance your mortgage, including:
- You have a pre-payment penalty on your current mortgage.
- Your home is underwater.
- Your credit score or over-all financial position has deteriorated since you took out your first mortgage. This makes it likely you’ll get a higher not lower interest rate, thus eating away at any potential savings.
- You’re nearing the end of your current mortgage, as you’re making mostly principal payments now (and a new mortgage means you’d have to start paying interest from scratch).
If you fall into any of these buckets, but still want to reduce the length of your mortgage, it may be to your benefit to make extra monthly payments toward your principal. While it won’t reduce your monthly payment or interest rate, it will reduce the amount of time you pay on the mortgage — and the total amount you pay over the loan’s life, since you’ll make fewer interest payments. This is assuming, of course, that you have the cash flow to do so, but adding even an extra $50/month to your payment can reduce your total cost by thousands over the life of the loan, and reduce the number of years you’ll pay on it. In some cases, the savings can be as good or better as re-financing.
Example Five Ten Twenty Club Savings From Re-Financing:
Let’s assume you have the national average mortgage balance ($148,000), for a $165,000 mortgage taken out at the peak of the housing bubble (2006) at the then prevailing 30-year fixed loan interest rate of about 6.25%. Assuming typical re-financing fees and costs, at the new 30-year fixed mortgage rate of about 4.15%, you’d reduce your monthly payment by about $295.00 and save over $21,000 in interest over the life of the loan.
Monthly Savings: $295.00 (Or about $10/day)
1-Year Savings: $3540
30-Year Savings: $ 613,391.35 (This assumes you invested the savings each year earning 10% market returns)
That $600,000 is the magic figure many experts recommend as the minimum amount needed to retire comfortably. So, if re-financing makes sense for you, it could potentially save you enough money to fund your monthly Five Ten Twenty Club goals — and retirement! Remember, your goal at the Five Ten Twenty Club is to commit to saving $5, $10, or $20/day, and this is one simple way to do so.
Have you re-financed your mortgage – or are you thinking about it? Tell us how you’ve used your savings in our discussion forum or in the comments section below!