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January 2012
Answer four questions before refinancing a mortgage
"Interest rates hit historic lows!" "Refinance Now!" "No-cost refinancing!" These advertisements urge consumers to capitalize on mortgage interest rates that have declined significantly over the past two decades. In December 1991, the average rate on a 30-year mortgage was about 8.25%; now it's about 4%. That said, mortgage refinancing doesn't make sense for everyone. Before you rush to your bank or online lender, be sure to answer these four questions.
- How much will it cost to refinance? In a refinance, you pay off the old mortgage and acquire a new mortgage. Most of the costs associated with the original loan — for appraisals, title insurance, loan origination, credit reports, home inspections, and so on — will be charged for the new mortgage as well. Even if your lender offers a "no-cost" refinance, such costs will probably be rolled into the new loan or factored into the new interest rate. "No cost" isn't really no cost.
- How much time is left on your existing mortgage? If you're nearing the end of your existing mortgage term, refinancing may not make sense. That's because the bulk of current payment is being used to reduce your principal balance. As a result, lowering your interest rate may not result in savings (after refinancing costs are considered). On the other hand, if you still have many years to pay on an existing mortgage, acquiring a new mortgage with a lower interest rate may indeed save thousands of dollars.
- How long will you stay in your home? Say you get a lower interest rate that shaves $150 off your monthly payment, but you stay in the home for just one more year. Does it really make sense to pay $4,000 to refinance your existing mortgage? To recover refinancing costs, you would need to enjoy those lower payments for over two years ($4,000/$150 per month = 26 months).
- Will you cash out your equity? Some homeowners refinance a mortgage to get cash for remodeling kitchens, paying off credit cards, or taking vacations. That's not always a great idea. Let's say your home is worth $200,000 and you have a $150,000 mortgage. That means your equity is $50,000. If you cash out $30,000 of that equity and, as a result, your refinanced mortgage increases to $180,000, your payments and long-term costs may escalate as well — even with a lower interest rate.
For help in analyzing the refinancing issue in your situation, contact our office.