Refinancing

Have you ever thought of refinancing your home loan? I believe most homeowners have. Recently, with the dip in interest rates, the thought has been more enticing than ever. Everywhere a homeowner turns, there is advertising for refinancing; television ads, in the newspaper, at the bank. How will you know when the right time to refinance is, and who will you turn to for the right advice. Experts have mixed opinions on refinancing, and lenders create the perfect advertising to make you think you need their product.

The first, and absolutely most important thing when considering refinancing your mortgage, is to ensure you beyond a doubt understand your current mortgage. You will have absolutely zero bargaining power to refinance if you don’t know what you have now. Senior Vice President at Lending Tree, Mona Marimow says, “Approximately one third of borrowers don’t know their current interest rate.” This is a scary thought! Borrowers must be prepared to negotiate to receive the best possible rates, but they face a disadvantage when they don’t know, or don’t understand what they currently have. Look over your loan documents; ensure you understand what they say. If you don’t, take the documents to your lender and have him or her explain. If it is still not clear, take them to another lender.

There are some things to consider if you are considering refinancing your mortgage. You will want to examine your existing mortgage, and ensure there are no prepayment penalties. You will also want to take a look at your current credit standing, and ensure you’re ready for the refinance. You should also consider the costs of refinancing, and if it will be worth the lower interest rate. Some fees to consider are the application fee, appraisal fee, documentation preparation fee, loan origination fee, flood certification, title search, lien recording fee, and other closing costs. These can rack up a hefty bill, so they unquestionably need to be considered when making your decision. Be wary if your lender is offering a no cost refinance, they simply don’t exist. Those fees are built into the loan somewhere, likely in the interest rate, or added into the principal balance.

The greatest gain in refinancing comes when your new rate is at least 2% below your current rate; however, some financial advisors believe borrowers can save big lowering their interest rate by only 0.5%. One thing to examine is how long it will take you to break even after refinancing. What this means is how much time it will be until you start to see a savings after paying all of the extra costs and fees to refinance your mortgage. You can calculate this simply by taking your total refinancing costs (÷) divide by your monthly savings (=) this equals how many months it will take to break even. (See example below.)

There are a few other details to look at when considering a refinance. Lenders will determine the value of your home through an appraisal. Depending on the type of mortgage you are applying for will determine the percentage of the value of the home the lender will be willing to give you. Stay realistic and don’t overestimate the value of your home. Try not to be hesitant to lock in a low interest rate if you do decide to refinance. Chances are, the longer you wait, the higher the rates will creep. Don’t focus solely on the interest rate when mortgage shopping either. Points, fees and terms are just as important. Don’t overlook a shorter term. It is likely the increase in your monthly payment is not as large as you may think, and rates on shorter terms are more favorable. Don’t forget, refinancing means starting your loan over from scratch. Most of the time, payments made in the first seven years only make up about 5% of the principal.

There are so many things to contemplate when considering a refinance. Reasons for refinancing can be different for everyone. In my opinion, the most important items to consider are the loan terms including costs and fees, and your breakeven point. If refinancing is a more favorable option for you, do it! Don’t let an advertisement make the decision for you, however. Take into account the long term.

Refinance Breakeven Examples

Current Mortgage
Original Balance: $175,000
Current Balance: $162,196
Payment Amount $1,027 / month
Interest Rate 5.8%
25 years remaining on a 30 year mortgage
Total Interest (Over 30 Years) $194,654

Refinance Option
Principal Amount: $162,196
Fees & Closing Costs: $6,480
New Payment Amount: $822
New Interest Rate: 4.5%
30 Year Mortgage
Total Interest: $133,660
Total Cost: $140,140

(Total Costs) $6,480
(Monthly Savings) $1,027 – $822 = $205
Total Costs ÷ Monthly Savings = # Months to Break Even
$6,480 ÷ $205 = 31.6097 months or 2.634 years

Current Mortgage
Original Balance: $100,000
Current Balance: $89,740
Payment Amount $477
Interest Rate 4%
About 25 years remaining on a 30 year mortgage
Total Interest (Over 30 Years) $71,870

Refinance Option
Principal Amount: $89,740
Fees & Closing Costs: $3,590
New Payment Amount: $403
New Interest Rate: 3.5%
30 Year Mortgage
Total Interest: $55,330
Total Cost: $58,920

(Total Costs) $3,590
(Monthly Savings) $477 – $403 = $74
Total Costs ÷ Monthly Savings = # Months to Break Even
$3,590 ÷ $74 = 48.513 months or 4.042 years