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Should You Refinance?
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When I purchased my home two, nearly three, years ago, I had a great interest rate of 5.75%. With the recent Fed rate cut of 0.75%, a question that has been swirling around the heads of my friends has been whether or not they should be refinancing. Some of them have loans at higher rates or HELOC’s and 2nd mortgages at higher rates – for them the analysis is worth performing. As for us, with the Bankrate quoted rates at around 5.40% for a thirty year mortgage (under 5% for a 15 year mortgage), the answer for us is unclear… this calls for an analysis!
Comparing Total Interest Payments
The current outstanding balance for our mortgage loan is approximately $224k and, given minimum payments for the remainder of the loan, puts us on pace for paying out a total of $217k in interest and $224k in principal. The $224k in principal is given, what interest rate do I need in order to pay less than the $217k in interest? According to the calculators at Bankrate, the answer is approximately 5.16% on a 30 year mortgage. This analysis does not include closing costs, some of which I would be responsible for even if the lender paid for the closing costs (at the very least, I’d have to pay the scam that is title insurance). In actuality, on a 30 year mortgage, I would need something that’s slightly less than 5.16%.
Lower Monthly Payment
Another consideration, if I were to get the break even mark of 5.16%, my payments would be $1,200 for 360 months – approximately $200 less than our current payment. If I felt that the extra cashflow was necessary, I would definitely go for a refinance if the numbers were right. As it were, we are currently paying extra each month (approximately $300) so that the 30 year mortgage is closer to a 15 year mortgage. Having a lower payment but paying more gives us the flexibility to treat it like a 15 year mortgage but only be obligated for a 30 year, should our cash flow situation tighten up.
What If? The 15 Year Mortgage
What if we went with a 15 year mortgage? Let’s say we could get a 15 year mortgage at 4.875% on my balance of $217k. The monthly payments would increase to $1750 each month (or $150 less than our current actual payment) but the total interest paid would plummet from $190k (the amount given the $300 extra paid) to $92k, nearly a hundred thousand dollars. Am I willing to save $100k (it’s really only a $75k savings given taxes) and lock in the $1700 per month payment? That’s a much harder question to answer.
Summary
Refinancing to a fixed 30 year mortgage doesn’t appear to be make much sense but refinancing to a fixed 15 year mortgage, given our extra principal payments, looks to save us $75k over the loan period. These all assume that there will be no closing costs but would I be willing to pay a little extra in front in order to get some savings in the long run… perhaps. I have to think about this some more, please share your thoughts in the comments and please tell me if I’ve done my math wrong!
Next Steps
I think the next step for me is to take a look at Lending Tree, where I like to go to get a quick snapshot of what’s available. When I bought the first time, I used Lending Tree to get a pre-approval letter and to help me get a better handle on what rates would actually be for me. They gave me a good snapshot, so I’m going to use them again to get a feel for what’s out there.
{ 12 comments, please add your thoughts now! }
Even with the surprising Fed rate cut today, don’t expect mortgage rates to do much for a while. Mortgage rates are more or less tied to 10 and 30 year treasury securities. That being said, the rate cuts are beginning to possibly set the trend to where treasuries may move in a way that does affect mortgage rates, but it won’t happen nearly as quickly as other rate changes.
But it does make sense to begin planning now to see what benefits a refinance could mean, especially if you’re considering moving to a 15-year loan. Given the monthly payment difference is relatively small combined with a possible lower rate in the coming 6 months or so, this could be a very attractive option.
It is actually something we’re going to be looking into this summer. Even with current rates, we could move to from a 30 year to a 15 year for about $200/month (not including any closing costs). And since we don’t plan on being in the house for more than about 5 more years, this would help tremendously when it comes time to sell with substantially more equity than we would have if we had stuck with the 30 year.
The question should not just be SHOULD you refinance – It should be asked whether you want to refinance to lower your payments, or refinance to shorten the TERM of the loan.
Their is great likelyhood of more cuts to come. I am going to nose around, but make sure my FICO is golden at the time to go!
We’ll be refinancing our ARM in the near future. Eventhough we have a year left on the initial term at 4.625% we can get a 30 yr. at around 5.5%.
Since we plan on staying in this house long term we’ll recover our refinance costs.
The decision to refinance needs to take into consideration how long you will be staying in the house. If we were moving in a couple of years we’d just let the ARM adjust.
I did run some numbers looking at 15 and 20 yr. vs 30 yr. If you invest the difference between the shorter term payments and the 30 yr. in a 5% savings account you will have nearly enough to pay off the principal at the same time as the shorter term. Of course this assumes discipline.
If you invested that difference in a Roth you could easily out distance principal amount left and either way the difference is tax free.
Set up a simple spreadsheet and run the numbers.
dont do it yet, wait atleast a month or two before you act. home equity loans, etc. will come down faster than mortgages since they are tied to different bond/treasury rates.
i think if it saves you more than a couple hundred dollars a year and you can find someone with no closing costs, do it. its a few hours of your time for thousands of $ in the long run.
i have several rental properties with mortgages in the 6-11% range that I am going to be making some rate changes on this year..
Talk about some food for thought! I was just thinking about re-fis myself. Thanks for bringing up the 15-year mortgage option, I hadn’t thought of that but it *might* work for us. I’ll have a lot of number crunching to do
Trying to make smartest decision.
You offered lots of info. I am close to retirement, teacher, will begin making art full time. 2k/month and what ever I can do each month in sales. So I have a 30yr 143k mortgage with 132k left @ 5.46 VA and 2nd 20 yr 15k left @ 8.69
25.5 left on the first 18yr left on second. looking to lower payment to be able to pay off car then attack mortgage as I am able. looking at combining both @ 5-5.25% 30 yr and pay every two weeks. payoff in 24 yrs, taxes 950 and ins 500 yr.
OK what do you think?
It’s good to see payment flexibility and cash flow considered. I’ve had friends choose the 15 year and it worked out well for them. If you are comfortable with the higher fixed (but lower than planned) payment on the 15 year it looks pretty good. I’d be tempted to go for it.
One point to consider with the 100k vs 75k savings after taxes is how much of that will really be deducted. It looks like the first year you would have about $10,700 in mortgage interest to itemize (assuming 12 payments, which might not happen since it’s the end of January, but you might be able to prepay in December). Depending on what else you itemize it will have a different value compared to the standard deduction. Then each year the interest will be lower, for example the 5th year it will be around $8500. Hopefully by then your income will be higher, but then your marginal tax rate might be higher also, so it’s value will really depend on what other deductions you have and how high the standard deduction is at that time.
Have you considered a rate amendment? Some mortgage companies will amend the mortgage without a refinance for little or no fee. While my ING Direct Orange Mortgage IS a 5/1 ARM (we intend to refi within 5 years to a 30-year fixed), they ARE willing to adjust my rate from 6.7% to 5.5% (or lower, by the end of this month) for a cost of $500 with not other costs or changes – it’s just one doc that gets added to the mortgage. The amendment restarts the “5″ part of the ARM but does not extend the mortgage or change the principal or payment terms. Since I will save $273 or more per month, it makes sense to do so since the investment will be regained within 2 months! If we kept the rate for 5 years (the max), we would save a total of $15,580 ($273 x 60 months = $16,380 – $500 fee). Other companies may offer the same option, especially considering the larger number of refis that MAY be coming.
Another factor that was important for me was the mortgage insurance. By the time I refinanced, I still didn’t quite have 20% equity (which would have eliminated the need for this insurance), but since I had been paying an additional 17% of my payment toward principal, I had it up to around 15%, which substantially reduced my mortgage insurance.
On the other hand, if the value of your home has fallen, you might have to pay a higher rate now because you might have a lower percentage of equity than when you first got your loan.
Nowadays it’s easier to get rid of mortgage insurance, though, so maybe that’s not so big a deal. I think you get get rid of it once you hit 20% of the value when you bought your house, whereas I had to wait until half the time on my loan went by, unless I wanted to pay more than I would save on appraisal fees (I was paying for 9.5 years).
In my case, I refinanced from 7.75% to 6.625%, from a 30-year loan to a 15-year loan (thus cutting 13 years off my loan since my first loan was already 2 years old) and from a medium mortgage insurance rate to a low one.
I will not be refinancing again because I have only five years left on my loan now, and closing costs will likely obliterate any savings in interest.
I’m sure it depends greatly on your situation. Variables such as your current interest rate, time left to pay off mortgage, interest rate you can get at 15/20 yr loans, and how rigorous you are with saving money.
I performed some spreadsheet calculations using excel financial functions and determined in my situation it would be a benefit to refinance to a 15 yr loan. This assumes I carry out all my investing until the end of the current 30 yr loan (I have 26 yrs left).
My 15 yr payment would be higher than my current 30 yr payment – about $300. If I invested this $300 difference over the next 26 yrs (if I did not refinance), versus refinancing and investing nothing for the 15 yr duration of the new loan and then invested my entire mortgage payment for the remaining 11 years (15+11 = 26 yrs), I’m about $45k in the hole. Meaning it would be better to refinance at the 15 yr loan. I took into account the difference I would pay in interest as well. Not sure if I took into account the tax benefits of having the mortgage deduction perfectly or not but I did my best.
Bottom line is that it wasn’t as big of difference as I thought it would be. And this assumed I would invest every last penny of my mortgage differences every month. I also assumed an interest rate of 8%.
A lot of it’s just a crystal ball crap shoot – making assumptions about your investment interest rates, your future savings habits, how long you’ll live in your current house, whether a meteor wipes us all out.
So I would do whatever you’re comfortable with. Not having a mortgage payment in 15 yr sounds pretty cool to me. And that extra $300/mo I have to pay on my mortgage, is basically a forced savings account at the 15 yr interest rate.
The value of my condo has gone down by about 20K. In order for me to refinance, I have to pay down the loan first (bank will only finance 80%).
Paying down the loan plus closing costs, the upfront costs are just too much to bear.
The current rate is attractive (comparing to what I have) but what is one to do?
JT