Investment & Financial Articles
Title: WHEN IS IT RIGHT TO REFINANCE?
Author: Tim McMahon
Article:
With "everyone" talking about the historically low mortgage
rates, you are ready to decide if it "pays" to refinance.
The "rule of thumb" supplied by mortgage companies is that if you
can reduce your interest rate by 1% it is usually profitable.
But there is more to it than that. Like how long are you
planning on staying in the house?
Realistically, the first thing
you need to determine is what rates do you qualify for and what
are the other costs (like points and closing costs). When
refinancing it is common to roll the additional costs and fees
back into the mortgage so there are no "out of pocket" costs.
But this allows the Bank or other mortgage holder to charge you
interest on these fees. At the current low interest rates and if
you choose a short time period for your mortgage the additional
interest will be relatively small. But even at these low rates,
if you have a 30 year mortgage, interest will end up doubling
the amount of fees over the 30 year life of the loan.
Assume you
took a 30 year, $115,000 First mortgage on a house 5 years ago.
The interest rate at the time was 7.5% and your principal and
interest payment was $765.10 per month. (If $765.10 sounds low
to you, remember your "actual payment" may also include mortgage
insurance, taxes and home owners insurance.) After paying
$765.10 per month or $9181.20/year for 5 years you have spent a
total of $45,906. Plus, you still owe about $108,000 on your
$115,000 mortgage and you still have 25 more years to go! Not
much of your payment is going toward principal! So the sooner
you can get out from under the better.
Recently interest rates
have fallen to around 5% so you consider refinancing. Assuming
Closing Costs, fees and expenses are about $3,000. you will have
to "borrow" $111,000 to pay off your $108,000. loan (or come up
with the $3,000.) from savings. If you decide to refinance the
additional costs for another 30 years... your loan amount would
be $111,000. and you would be almost back to where you started 5
years ago... but your payment would drop to $595.87 for a
monthly savings of $169.23
Although it might be nice to have an
additional $169.23 to spend each month, the question is what
will you do with the money? Go out to eat more, buy more toys?
Invest it in your retirement fund? Or just "blow it"? If you
just "blow it"... all you have accomplished is that you are in
debt to the bank for an additional 5 years. Not a happy
prospect...
What if you set the mortgage term to 25 years? In
that case, your payment would be $648.89 saving you $116.21 per
month. So for an additional $53.02 per month your mortgage term
remained the same. Personally, I think that is a better
solution. At least you aren't pushing your retirement out an
additional 5 years while you continue paying your mortgage.
Remember, the original question was... Is it worth it to
refinance and pay the additional $3000, or just keep paying on
the old mortgage? Keep in mind, as soon as you sign the papers
the equity you have in your house drops by $3000! Assuming you
chose the 25 year mortgage (with the $116.21/mo savings) it will
take you 25.8 months to break even ($3000/$116.21) because at
that point you will have saved the $3000 it cost you to
refinance. So if you intend to stay in your house 3 or more
years it would pay for you to refinance.
But what if you took it
one step further? What if you kept your payment the same and
reduced the term of your mortgage as far as possible? A $111,000
mortgage at 5% with a payment of about $765 would require a term
of 223 months or about 18.5 years. Assuming you could get an
18.5 year mortgage and you intended to stay in your house that
long, this would be an excellent move! You have drastically
reduced the amount of money you will pay the bank over the life
of the mortgage and you are free and clear 6.5 years earlier!
Even if you move sooner, your equity will be building faster so
you will have more money when you sell.
Unfortunately, lenders
do not usually let you choose an odd term length like 18.5 years, so you
would have to choose either a 20 year term with a
payment of $732.55 which would still save you about $30/month
but also knock 5 years off your loan (and build equity somewhat
faster). Or you could choose a 15 year term with a payment of
$877.78 which would actually cost you about $110/month more than
what you are currently paying but would knock a full 10 years
off your mortgage.
If your income has risen since you got your
initial mortgage and you could swing it... it would be money
well spent. For those with higher incomes who have difficulty
saving, this is a great idea because it actually forces you to
save a little bit more each month and once you get used to it,
you won't even miss it. Perhaps you can remove the mortgage
insurance off your mortgage. On the original loan, you might
have to pay it for the first 10 years, so you would still have
to pay it for 5 more years. But... if you have made improvements
to the home... or property values have increased dramatically in
your neighborhood... you might be able to get the new loan
without the mortgage insurance. If you can, you will save an
additional $100/month! With that saving you can move to the 15
year mortgage without mortgage insurance for the same amount
that you are currently paying for a 30 year mortgage with
mortgage insurance. Not bad eh? Whack 15 years off your mortgage
just like that!
Another way to reduce the monthly payment is to
reduce the amount you borrow. If you could come up with the
additional $3000 in closing costs from savings, your monthly
payment on a 15 year mortgage would drop from $877.78 to $854.06
.. or only about $89. per month more than what you are
currently paying. Is it worth $89/month to knock another 5 years
off your mortgage? That depends on your personal circumstances!
If your budget is already stretched to the limit, or it will put
you at risk if you lose your job, NO. But if you can find a way
to come up with $3.00 per day, (perhaps by giving up cigarettes,
or skipping a trip to the vending machine or to McDonalds) it
will save you thousands over the life of your mortgage! To
choose from dozens of places to search for the best mortgage
rates check out http://yourfamilyfinances.com/yff/Resources.aspx
Useful Mortgage Calculators
http://yourfamilyfinances.com/yff/calculators.aspx
Tim McMahon, Editor Financial
Trend Forecaster and
InflationData.com The Place in Cyberspace for Inflation
Information www.YourFamilyFinances.com www.fintrend.com
www.InflationData.com About the author:
Editor of Financial Trend Forecaster since 1997. Also editor of
InflationData.com and YourFamilyFinance.com
|