Lots of refinancing questions from clients recently. Yeah, the rates are super low. Probably wise to take advantage of them if you have a good enough loan-to-value ratio for your home. But before you jump on the bandwagon, here are some things to think about:
How long are you going to stay in your home and what rate do you have now?
There are costs involved in a refinance. Likely you have to pay a point (one percent) to the lender for originating the loan, a fee for an appraisal and title and escrow fees. These can usually be wrapped in your loan so you don’t have to have the cash, but this also means the total amount of your mortgage will increase. You need to figure out when the savings from the lower payment make up for these costs – what is the break even point? For example, if you save $100 a month on payments and your costs are $3,000 then it will take you 30 months to make up for the cost of refinancing. If you live in the home longer than 2.5 years then, financially, the refinance makes sense.
Do you have a pre-payment penalty on your current mortgage?
Some loans have a cost to you if you pay them off before a certain amount of time has passed. If you are refinancing, you are paying off your old loan. You will have to add the prepayment penalty to your cost of refinance. Using the example above if the penalty is $1,000 then your cost will be $4,000 and the breakeven point will be 40 months or 3.33 years.
How long do you have left on your current mortgage?
When you refinance you are not building equity, you are starting all over. Mortgage payments are mostly interest in the first years you are paying. If you are in the middle of a 30 year loan you have started to notice a nice reduction on the principal of your loan. When you refinance you are going back to square one and starting with an interetest heavy payment once again. Will paying this ‘cheaper’ interest for 30 years really be cheaper than continuing to pay the higher interest rate for the time you have left? Depends. Once again you must look at the rate difference and how much savings it creates. But also, what are you going to do with the difference, the monthly money you will save? If you put it back into paying down your loan, the refinance is likely a great idea since it will pay down your loan even faster. This takes some more advanced calculations, let me know if you need any help with figuring this part out.
How do you choose a lender to complete your refinance?
Check with the bank that holds your mortgage currently. Sometimes they will be able to ‘streamline’ the refinance and you will have less closing costs for the loan. It is always smart to check around for a deal but make sure you are comparing apples to apples. There is a difference between the ‘interest rate’ and ‘APR,’ some banks quote your closing costs with taxes and insurance hold backs and others don’t, etc…
What if you don’t have the LTV (Loan to Value) to refinance?
Yep, I am in this position right now and I am S.O.L. The best I can do is save some money so I can do a ‘cash in’ refinance – pay my loan down until I have the LTV to qualify for a loan. If I can manage to save this money it is probably worth it to gain the much lower interest rate, that is because the plan is to stay in my home for a long time and I believe that Seattle real estate will appreciate.
Some people may qualify for a HARP refinance. I won’t go into that as it is a whole post on it’s own but there is more info on the HARP Website.