Interest rates have been so low for so long that nearly everyone has refinanced. But there are still some laggards – people who were waiting for home prices to rise or interest rates to fall further, or for their credit scores to improve, or for underwriting conditions to ease. Now that rates have popped up a bit, the refi question is tougher to answer.
Any time you refinance, you should consider the costs of the refi, and even on “no points, no closing cost” loans, there are costs. Fees include appraisal and title reports, a higher interest rate if you take cash out, a higher interest rate for “no points” loans, documentation costs, even FedEx costs to transport the refi package. “Serial refinancers” lose much in the way of savings when these costs are repeatedly incurred. Calculate your savings versus expenses to figure out how many months it will take to “repay” the costs via the lower mortgage payment, and remember to add in whatever you haven’t made up in costs from your last refi.
When you refi from a mortgage with, say, seventeen years remaining, to a thirty year mortgage, you will not necessarily save money even if your payment declines. That’s because the long life of the mortgage can result in more interest even if your rate is lower, because you pay it for longer. You can control the interest you pay by prepaying your mortgage. Making an extra payment of just $50 more per month on a thirty year, 4% mortgage saves you almost $15,000 in interest, and shortens the mortgage to a little over 27 years. Making an extra $100 per month payment saves you $26,800 in interest and shortens the mortgage to 25 years. So if you don’t need a lower payment for budget reasons, it might be better just to prepay your existing mortgage versus doing a refi.
If you need a lower payment, you might consider an adjustable rate mortgage. Fixed period ARMs can give you some relief from fluctuating interest rates because a portion of the amortization period has a fixed rate. Take a good look at the highest your rate can go, and how much it can increase in any one year. If thirty year mortgage rates are 4.5%, and you can get a 5 year ARM at 3.5% with a 1% cap on the increase per year, then it will take at least five years to reach the prevailing 4.5% rate. That’s a lot of years for savings to accrue to you. If the ARM rate can get to 7% though, you’d better be ready for that.
Another quirk of ARM mortgages is that the adjusted rate – once it does start adjusting – applies only to the outstanding principal balance, not to the original loan balance. So if after four years you inherit a hunk of money and use it to pay down your mortgage, even a higher rate may not result in a higher payment for you.
This information is just the tip of the iceberg when it comes to mortgage financing. Even your loan officer might not understand every nuance of every mortgage alternative available, and most won’t think about a particular mortgage product relative to your specific situation, so involve your financial advisor when you refi. A short conversation and a couple calculations could save you big bucks.