When mortgage refinancing makes perfect sense
Historically low mortgage rates have led to a sharp increase in refinancing This year. If you have the financial profile to qualify for the best refinancing rates, it can be a good move.
But before you embark on a refinance, Suze Orman has a few tips you should consider.
If this is delaying you in paying off your mortgage, think about how much you are actually saving.
For example: If you have 22 years left on a 30-year mortgage and you refinance into a new 30 year mortgage, you’ve just added eight years to your home repayment schedule. Running out of a mortgage for another eight years may outweigh the benefits of a lower interest rate.
“Don’t refinance more than the length of your term remaining on your mortgage,” wrote Orman, the well-known personal finance expert and host of the podcast.Women & Silver, ” and one NextAdvisor contributor.
This rule won’t apply in every individual situation, but it does highlight an important point: When it comes to refinancing, the interest rate isn’t all that matters.
Does refinancing make sense to you?
Refinancing has the potential to save you a year’s salary or more in interest. But you have to go about it the right way, and that means using the numbers for your own situation.
Take Orman, for example, with a 30-year mortgage that was paid off for eight years. The middle house for sale in the United States is listed at $ 349,000, and the average deposit for first-time buyers is about 6%. With a 30-year loan at 4.5% interest, you owe about $ 439,000 in principal and interest over the last 22 years of the loan, according to the NextAdvisor mortgage calculator.
If you’ve refinanced at 3.5% interest on a new 30 year mortgage, your monthly payments would decrease by $ 400. But you would pay $ 10,000 in additional interest over the life of the loan. Instead of the $ 439,000 you had left on the original mortgage, you would now be required to pay $ 449,000 for the new mortgage refinance.
| Years left to pay | Interest rate | Monthly payment | Total remaining capital and interest due | Closing costs (approximately) | |
|---|---|---|---|---|---|
| Initial mortgage | 22 | 4.5% | $ 1,662 | $ 439,000 | n / A |
| New mortgage refinancing | 30 | 3.5% | $ 1,248 | $ 449,000 | $ 15,000 |
By paying $ 400 less each month, it would take you 25 months to clear the additional $ 10,000 from the new loan. Also, closing costs over any refinancing could cost around $ 15,000, which would take around 37 months to clear. So now, it will take you 62 months, or 5 years, before you stand out in math.
If you’re disciplined about saving and investing with your lower monthly payment, or if you use the opportunity to pay off other debt, refinancing can still be a smart move. But as Orman suggests, consider the extra years you add to your mortgage and how they will increase your overall costs.
Also consider how long it will take to get rid of your debts on your home. When it comes to budgeting, being completely free from a mortgage payment will open up great opportunities to save, invest for retirement, and enjoy your money.
Shorter term refinancing
On the other hand, refinancing into a shorter term mortgage can be a clear victory.
Interest rates are lower on 15-year loans versus 30-year loans. In this same example, if you have instead refinanced in a 15 year mortgage with an interest rate of 3%, you would save $ 94,000 in interest compared to the original loan. Plus, you’d be free from mortgage payments seven years earlier.
The trade-off is that you will be paying around $ 250 more per month than maintaining the original loan.
| Years left to pay | Interest rate | Monthly payment | Total remaining capital and interest due | Closing costs (approximately) | |
|---|---|---|---|---|---|
| Initial mortgage | 22 | 4.5% | $ 1,662 | $ 439,000 | n / A |
| New mortgage refinancing (30 years) | 30 | 3.5% | $ 1,248 | $ 449,000 | $ 15,000 |
| New refinancing mortgage (15 years) | 15 | 3% | $ 1,919 | $ 345,000 | $ 15,000 |
When refinancing probably doesn’t make sense
Refinancing is not free.
Adding years to your mortgage can add up to thousands of dollars in additional interest, and closing costs will reduce your savings as well. Even in a “free of charge“To refinance, taking out a new mortgage will cost you between 3% and 6% of the total mortgage amount.
So the value of refinancing changes if you don’t plan to hold the home for the long term. You need to be sure that you will be staying in the house long enough that the savings outweigh the closing costs of the refinance. If you are planning to move within the next 2-3 years, refinancing is not the best option.
Another thing: the refinancing interest rate you can qualify for is highly dependent on your credit score and overall financial health. If you have a low credit ratingit will be more difficult to qualify for mortgage refinance. You also won’t get the lowest interest rates that make the headlines. In this situation you’d better improve your credit and consider refinancing in the future.
Refinancing your mortgage is a decision that affects other areas of your financial life. You must therefore balance this choice with your other financial priorities. If the pandemic reduced your income or made your income less secure, the money you would spend on closing costs could be better used for create an emergency fund instead of.
Low interest rates are a great reason to refinance. But they shouldn’t be the only reason. Doing the math on when you’ll break even on the new interest and closing costs will help you determine if this makes sense for you.