Refinancing your mortgage makes sense when doing so would save you money. Interest rates have fallen lately. Has your credit score improved to the point where you’ll qualify for a better rate? Do you want to switch from a 30- to a 15-year home loan? Remember that there are costs involved so you’ll have to carefully evaluate whether the effort and expense are worth it.
Let’s say that after putting down $80,000 you borrowed $320,000 for a home loan. At that time, the best mortgage interest rate you could get was 7 percent, giving you a monthly payment of $2,128.97. Wouldn’t a refinance lower that payment? There are two situations where, most of the time, refinancing simply isn’t worth the trouble.
The first situation is if you’re planning to move anytime soon—closing costs on a refinance would eat up any savings you’ll have with lower mortgage payments. The second is when you’re nearing the end of your mortgage.
When you start paying off a mortgage, the bulk of that money goes to interest. In this case $1,866.67 with that first payment. Only $262.30 would go to principal with that first payment, maybe enough to own the birdbath in the front yard. At 7 percent interest, just over 20 years in, you’re starting to pay off more principal than interest. If you’re nearly the end of your home loan’s life, as long as there’s no prepayment penalty, rather than go through the hassle of refinancing, it makes more sense to add additional payments to apply to your principal to lower your mortgage costs.
If you’re six years into a home loan, the situation is very different. Let’s posit that you’ve gotten a raise, you’ve paid down your bills and your credit score now stands at 750, qualifying you for the best rate on a 30-year fixed mortgage, which is 4.25 percent. After January’s payment, on your initial $320,000 home loan you would still owe $296,612.97 with 24 years left to go. That would be a good time to consider refinancing, because you haven’t yet made much of a dent in the principal. In fact, January’s payment only covered $396.41 in principal and was primarily interest, $1,732.55 to be exact.
If you were to take out a new 30-year home loan on the principal, your payment would drop to $1,429.16, a savings of just under $700 a month.
If only it were that simple.
Let’s drill down and look at the details. The process of refinancing is similar to what you went through the first time you applied for a mortgage, with comparable closing costs that will run 2.5 to 5 percent of your outstanding principal. If somebody offers “no-cost refinancing” it’s not that the process becomes free, it’s just that the costs get added to the principal of your mortgage.
So do a rough estimate. Add 5 percent and see if a refinance is still worth it. With a 5 percent surcharge in our example you’d still be paying less, just $1,532.12 per month. Compared to your current payment, you’d be be saving about $600 every month, so let’s delve further.
To refinance, you’ll have to pay for getting your credit checked, handling your loan paperwork, verification by attorneys that the contracts are legal, inspection of your home, surveying your property, appraising your property, searching the title to make sure there are no unpaid liens and covering lender title insurance to ensure the bank doesn’t get burned by a bad title. Don’t forget to shop around. Rates vary from one lender to another.
Don’t think you’re limited to move from another 30-year loan, to a new 30-year mortgage. If you can handle the higher payments converting to a 15-year home loan, you’ll lower mortgage costs substantially and own your home free and clear sooner.
Right now, with the stock market in a funk as of this writing, it’s a great time to consider refinancing, because mortgage interest rates have eased lower lately. But remember, they are expected to creep up to 5 percent or more this year as the Federal Reserve Bank tapers off its buying of mortgage back securities.
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