January 31st, 2017 5:16 AM by Jackie Graves, President
Should you refinance your
mortgage? Before deciding whether or not to refinance, ask yourself
these five questions:
What is the purpose of the refinance? Do you want to pay less
interest or lower your monthly payment? Do you want to get out of a variable
rate mortgage and lock in a low rate?
How long have you been in your property? And how long do you plan
to stay in the property?
Can you qualify?
Do you have enough cash to cover the the closing costs?
Have you shopped around for the best rate?
The right answer is not always obvious. And you need to be
careful: most people giving you advice will be receiving large commissions
if you do refinance. Your interests are not aligned, and you should do your
homework before you start.
1. Why Do
You Want To Refinance?
There are three reasons why people consider refinancing their
Current market interest
rates are lower than your existing mortgage interest rate.
The savings from locking in a lower interest rate can be
considerable. For example, a $200,000 mortgage at 5.5% would cost $43,995 more
over 30 years than a 4.5% mortgage. Clearly that is savings worth chasing.
Warning: Pay close
attention to the total number of years you will be in debt across all of your
mortgages. As a general rule, the longer you are in debt the more interest you
will pay, regardless of the interest rate. Imagine you have a $200,000 mortgage
for 30 years at 5.5%. After 10 years, you refinance into a new 30 year mortgage
at 4.5%. Yes, the new interest rate is lower. However, you will now be in debt
for 40 years in total. And over 40 years you will pay $237,390 of
interest. Had you kept the 5.5% mortgage for the 30-year term, you would have
only paid $208,808 of interest. The lower interest rate ended up costing more
Tip: The best
way to save money on your mortgage is to pay off your mortgage
faster. When looking to refinance, try to get a 15-year mortgage. If you
can’t afford the payments, make sure you pay extra every month on your new 30
year mortgage to ensure you aren’t staying in debt longer than you should.
You want to lower your
Remember: lowering your monthly payment and saving money are not
the same thing. If your objective is to reduce the amount of interest you pay
on your mortgage, your goal is to pay off your mortgage as quickly as possible.
By refinancing and extending the term, you will most likely end up paying much
more interest over the life of the loan.
lowering your monthly payment, you are likely increasing the total cost of
owning the home. Just make sure you do the math and fully understand how much
more the home will cost you.
Tip: If you are
having difficulties paying your current mortgage payment, refinancing could be
a good way to adjust to your new economic reality. If your situation improves,
try to put as much as possible to your mortgage payment to accelerate
You want to lock in a
fixed interest rate.
Interest rates on mortgage have increased since the election of
Trump. And, over time, interest rates are expected to increase further.
However, by historic standards, interest rates are still very low. If you have
a variable interest rate, now might be the time to lock in a lower rate. But
the advice doesn’t change: keep the term as short as possible to save the most
Long Have You Been in Your Property? And How Long Do You Plan To Stay?
In the first years of your mortgage, most of your payment goes
towards interest. On your first payment, expect 81% of the payment to go
towards interest. On your last payment, only 0.5% of the payment goes towards
But this causes a problem. If you have only had your mortgage for
the first few years, your mortgage balance has not reduced by much. And if you
continue to refinance every five years, your balance will barely budge.
People buy homes to build wealth. However, the closing costs
associated with refinancing the mortgage and the lack of amortization in the
early years could actually add considerable costs. If you refinance, make sure
you plan to stay in your home for a long time to get the benefit of
amortization. Frequent moves and refinancing activity can actually make owning
a home a worse economic decision than renting.
Although it is starting to get easier to qualify, mortgage
standards remain tight by historic standards. Typically, the three most
important parts of your application would be your credit score, LTV and
debt-to-income ratio. Most mortgages are agency-backed (Fannie Mae or Freddie
Mac), which means there are very specific versions of credit
scores used for mortgages. You can buy those scores from myFICO.
However, free credit scores (like VantageScore from CreditKarma or the FICO on
your credit card statement) are good proxies. According to the Fannie
Mae guide, you will want a credit score above 660. If your
score is lower, you should investigate an FHA mortgage.
4. Do You
Have the Cash To Cover Closing Costs?
Closing costs are not small. On a $200,000 mortgage, estimated
closing costs at Wells Fargo are $6,514. Many lenders will allow
you to finance the closing costs, subject to the LTV. If you are trying to
reduce your monthly payment, that might be just fine.
However, if your goal is to save money, you should avoid financing
the closing costs. If you finance $6,514 over 30 years, you will end up
spending an additional $5,368 of interest on those closing costs. It is much
better to pay for the closing costs in full, rather than financing the costs.
You Shopped for the Best Mortgage Rate
When looking around for a mortgage, there are still surprising
rate variations. The CFPB offers a mortgage rate
tool to help you see the best rates for your profile. Unfortunately,
the tool does not provide the name of the lenders. MagnifyMoney
has a guide that
explains how to use the CFPB tool to find the best mortgage rates. Although
the tool will not give you the name of the lender, it will give you
enough information to ensure you get the lowest rate with a bit of work.
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