July 28th, 2020 9:33 AM by Jackie A. Graves
With COVID-19 creating havoc and uncertainty within our economy, mortgage rates are hitting historic lows. According to Freddie Mac, the national average rate dropped earlier this month to an all-time low 2.98%. In fact, Mortgage News Daily reported that the average reached a seemingly impossible 2.87% on Thursday.
When homeowners are bombarded with news about ‘record-low rates’, they often have one thought on their mind. Is this the time to refinance? I’d estimate that half of my clients have asked me this question over the past few months. When on paper, this may seem like a no-brainer; lower rates means you pay less in interest, saving tens of thousands of dollars over the life of the loan. But the answer isn’t always so obvious, and like everything when it comes to personal finance - it depends on your specific circumstances. It’s like a puzzle; there are five pieces you must consider, and you have to fit them together to look at the whole picture. Ask yourself these 5 questions:
1. Do I qualify for a better rate? Before you do anything, make sure you can get one of these low rates. To take advantage of today's low rates you will need, among other things, to have a good credit score. Be sure to shop around and get quotes from several lenders. More here on how to qualify for a low mortgage rate.
2. Is my current mortgage rate high? This is subjective, of course. For those unlucky enough to get a mortgage in the 80s, rates got as high as 18.63%. That is clearly a horrifically high mortgage rate, and if your rate is in the double digits then the answer is yes, the rate is too high and you should refinance. What about those homeowners who bought their home in 2007 and got a rate of 6.34%? This is double the rates offered now, so this rate would be considered high today. However, the answer is not as obvious for most. What if your rate is 4.5%? That’s over a full percentage point higher than the rates today. Should you refinance? This requires some math.
3. What will my savings be at a lower rate? Let’s say in 2011 you bought a home for $120K, and after your $20k downpayment, you were left with a 30 year, $100k mortgage loan at a rate of 4.5%. Today, you are approved for a 3% rate. Using a simple mortgage calculator, you can calculate the following (not including taxes, insurance, etc):
Current mortgage payments at 4.5% = $507/month
Refinanced loan at 3% = $348/month
Savings = $159 / month.
So, is this a no-brainer? You’re saving money each month, and in many situations this is enough to justify refinancing. But, there’s an additional cost to consider.
4. What are my closing costs? Since you’ve already bought a home, you’re familiar with closing costs. Typical fees include application fees, loan origination fees, appraisal fees and other (sometimes optional) expenses. What some may not know is you have to pay most of those same costs when refinancing your home. While there’s no standard way to calculate, you can generally plan on paying about 2% to 5% of your refinance amount in closing costs. National average closing costs for a refinance are $5,779 including taxes and $3,344 without taxes, according to the latest data from ClosingCorp, a real estate data and technology firm. With our current example, let’s say your closing costs are $2,475.
5. How long do you plan to stay in your home after refinancing? This is where closing costs matter, and the answer is critical. You have to have an idea of how long you’ll be in this house to understand if you will save or lose money by refinancing. This is referred to as your breakeven point. The breakeven point in refinancing is the amount of time it will take for you to recover the closing costs considering the amount you’re saving. There are several components to consider, such as how much is going towards principal vs. interest. This is where a refinance calculator comes in handy. But for our purposes, you can use some crude math to give you an idea. If you moved one year after refinancing, you would save $1908 in payments ($159 savings x 12 months). But you paid $2475 in closing costs. In this case, you are not saving enough money to justify refinancing, and in fact would end up losing money. A refinance calculator that includes all factors shows your breakeven point is at 3 years.
Your answer? Taking all questions into consideration and in the simplest terms, in this scenario financially it only makes sense to refinance if you are planning to stay in your home for another 3 years.
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