Recent headlines proclaim that mortgage interest rates are at their lowest levels in 50 years. And you are wondering whether you should refinance your mortgage.
It all depends on your current mortgage interest rate, your monthly payment, and the remaining amount of time on your current loan. It could be a great time to lower your payment, shorten your loan term, or move to a fixed rate loan from a variable rate loan.
Before you start, make sure you understand your current loan (30-year fixed, 5/1 ARM, etc.), the interest rate, the payment, and the remaining term.
Use these tips to decide whether to refinance your mortgage.
1. Check the interest rates for new loans.
Check with at least three lenders – your current lender, a credit union (or bank) and an online lender. Compare the new monthly payment to your current one. Remember, that if you are escrowing your homeowner’s insurance and property tax payments then that part of the payment stays the same.
Use an online site for internet-based lenders and non-bank lenders. The key here is to get the lowest rate possible with few closing costs and no points. Points are prepaid mortgage interest and generally aren’t advisable unless you are staying in your home for a very long time.
If you’ve never heard of an online lender, do an internet search on the company name with the word “complaints” in the search. You’ll often come across the Better Business Bureau entry of the company, so you can see if they are legitimate.
In addition, often internet lenders require you to put in your email. I have established a separate email account for these types of things. Once I’m done with the process, I’m not inundated with continuing offers that clog my inbox.
2. Shorten your mortgage term.
Consider a new mortgage loan that matches the remaining time you have on your mortgage. For example, if you have 23 years left, look for a new 20-year mortgage. Interest rates on shorter mortgages are lower than those for longer mortgages.
It doesn’t make a lot of sense to replace a 30-year mortgage with another 30-year mortgage if you are 10 years into your current mortgage. You’ll be adding another 10 years before you are debt free. There are exceptions of course, if cash flow is an issue and you want to free up monthly cash flow.
Say you have a $400,000, 30-year, 3.5% fixed rate mortgage with a payment of $1,910/month. You have 23 years left and an outstanding balance of $345,000.
If you refinance the balance of $345,000 with a new 20-year, 2.5% fixed loan, then the payment is $1,828/month – a savings of $82/month. In addition, you are chopping 3 years off the length of the mortgage. And these new lower payments contain more principal repayment than interest. You will be building more equity in your home than you otherwise would have been doing under the old loan.
The same idea applies if you are replacing an adjustable rate mortgage (ARM) with a fixed rate one. Look to see how many years are left and see if you can find a new mortgage with a lower payment.
3. Do your breakeven calculation.
A refinance will cost money – closing costs, title insurance, appraisal, so-called “document fees”. The key to is when will you recoup those costs.
For example, your closing costs are $2,400. Your new mortgage payment will be $200/month less than your current payment. It will take 12 months to recoup the costs. That is a pretty good deal.
Try to recoup your costs within two to three years.
Ultimately, its up to you to decide whether to refinance given your personal situation, but consider these tips if you pursue a mortgage refinance.