There is perhaps nothing more appealing for a homeowner than refinancing one’s mortgage to a lower rate. The possibility of lowering monthly payments, month-after-month, year-after-month, holds immediate and long-term appeal.
While low vs. high seems to be non-controversial, it does not always make practical financial sense. So before you return a call from that enthusiastic mortgage lender offering you the opportunity to save thousands of dollars in interest payments, keep in mind a few crucial factors that could impact whether your savings is real — or illusory.
The Two-Point Threshold
A traditional refi rule was to look for a two-point savings; that is, if you could lower your rate from 8% to 6%, you were probably going to come out ahead.
This is an arbitrary metric and it’s more helpful to evaluate your break-even point: That is, how many months it will take you to break even from the refi costs.
Consider the following: If your existing 30-year mortgage of $300,000 carries a 7% interest rate, your monthly premium + interest payment would be $1,996. If you refinanced at 5%, your new monthly payment would be $1,610, a decrease of $386.
Now let’s assume closing costs of $3,000. At a monthly savings of $386, it would take $3,000/$386 = 7.77, or nearly 8 months to break even. As long as your current plans to remain in the house exceed seven months, the refinance would make financial sense.
But … Check the Fine Print
A mortgage is not a mortgage is not a mortgage. Which is not to say that a mortgage is not a mortgage; just that, well, not all mortgages are the same. So don’t look solely at the annual percentage rate (APR) in selecting a new rate. There are a number of factors to consider in evaluating whether that shiny, new refi is all it’s cracked up to be.
Look carefully at the loan term; shorter loans carry (typically) lower rates, though they bear a higher monthly payment. However, if you can afford the higher monthly payment, you’ll pay far less interest over the term of your loan.
Loans are either fixed, where the interest rate stays the same over time; or variable, in which case the rate can increase after a set number of years (one, five, etc.). While the latter adjustable rate mortgage (ARM) may offer a lower starting rate than a fixed-rate mortgage, the ARM’s interest rate may increase sharply over time if interest rates go up.
If you plan to remain in your current home for many years, you may prefer the predictability of a fixed rate mortgage. However, if you intend to sell your home in the next few years, an ARM may save you more money over time.
Points [NOTE: At this point, the previous article included a monthly payment table that calculates savings for a fictitious mortgage scenario. Not sure that it’s necessary to include it??]
Certain loans may incur points, also known as a discount fee or origination fee. This is what you owe the lender at closing. Some lenders may offer you a “zero points” mortgage, but if the interest rate is higher than one that carries a point or two, the net savings may be negated. It’s therefore helpful to determine whether the lower rate produces a more substantial savings than a loan that charges points. (NOTE: One int = 1% of the loan value.)
Keep in mind, too, that a refi incurs a number of mortgage-related costs, including:
- Application fee: $75-$300
- Loan origination fee: 0-1.5% of loan amount
- Points: 0-3% of loan amount
- Appraisal fee: $300-$700
- Inspection: Up to $500
- Legal costs: Up to $1,000
- Title search and insurance: $600-$1,200
- Survey: $150-$600
- Prepayment penalty: Varies
Loyalty Counts (Maybe)
If you’re considering a refi, check with your current lender. Having already processed your financial information, he/she may lower the fees that they typically charge to refinance a loan.
Of course, with such a substantial sum of money at stake, shop around to multiple lenders to determine that your bottom-line makes sense on your … well … bottom-line.
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This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal.
This material was prepared by LPL Financial, LLC
Neither LPL Financial nor its registered representatives offer mortgage or mortgage lending services.