Is now a good time to refinance?

Family in living room

A frequent news alert people see these days is: “Mortgage rates drop to record lows”. And seeing an opportunity to save money, a lot of people end up clicking to see if they can benefit from that.

But news articles are written to keep you updated about what’s going on. What they rarely offer is an insight into whether the drop in rates would yield tangible benefits to you.

Some people decide to refinance without understanding the true benefits. And some refrain from doing anything only because they don’t understand the implications very clearly.

So let’s try to understand whether it makes sense for you. So when you see such a news item next time, you’ll hopefully make a more informed decision.

When should you think about refinancing?

Mortgage rates and one’s own financial and personal situation change all the time. If you belong to one of the following categories, you have a good reason to be looking into a refinance.

  1. Mortgage rates have dropped and your current rate is higher than prevailing rates
  2. You have other debts (credit card, education loan, auto loan etc) where the rate of interest is higher than the rate at which you can refinance your home.
  3. You have a private mortgage insurance because your loan amount is high (i.e. more than the typical 80% of home value)
  4. If your financial situation has changed and you can afford larger payments to pay off your loan sooner. 
  5. If your credit score has improved significantly since you got your mortgage, it might save you a lot by refinancing.

How much will you save?

People read about drop in rates and the first question that comes to mind is how much will I save every month. There are plenty of mortgage calculators on the internet to help you with that. Read about how to use mortgage calculators.

– Type your loan amount, mortgage term and the current rate. See your monthly payment

– Now do the same again, but with your new rate.

– The difference in payments is your savings every month.

Let’s see this with an example

Say, you have a 30Y mortgage with a loan amount of $300,000 and the rate on your mortgage is 3.5%. Your monthly principal and interest (P&I) payment will be $1347. See: Annual Percentage Rate Disclosure

Now let’s say, with a refinance, you can get a rate of 3.0%. Your monthly P&I payment will go down to $1265.

That amounts to savings of $82 a month or approximate $1000 a year. That’s a reduction of almost 6% on your monthly payment.

How do you ascertain if that’s savings enough? The idea of breakeven

When you get a mortgage, there are closing costs associated with it – From appraisal to title insurance and from origination fee to escrow. According to Zillow, you pay anywhere between 2 to 5% in closing costs.

In the above example, say your closing cost is equal to 2% of loan amount. That means you’ll pay close to $6,000 in closing costs

Since you pay $6,000 in closing costs and save $1,000 a year, it’ll take almost 6 years for you to break even. 

How so? Well, you pay $6,000 today to get the new mortgage, which you wouldn’t have to pay otherwise. Now if you save $1000 a year as a result, it’ll take you 6 years to break even on the closing costs.

 

Isn’t that quite long?

Well, that depends on how long you plan on keeping the mortgage. There are two primary reasons people get out of their mortgage early:

(1) Either they refinance their mortgage for a better deal, or

(2) They sell the property.

Whatever be the reason, there are three major scenarios you should take into account:

Scenario 1: You keep this mortgage for longer than break even period

Let’s say you expect to keep your mortgage for the full-term of 30Y in the above example. 

If your breakeven period is only 6 years, it’s a good idea. Why? Because you’ll break even in the first 6 years and for the remaining 24 years, you can save quite a lot.

Scenario 2: You keep this mortgage for a lot shorter than the break even period

Let’s say you, instead, expect to sell the home in only 3 years, long before the break even period. Or you think rates will drop significantly in 3 years and there is a good chance you’ll refinance much before the break even period.

In either of those cases, it may not be a good idea to refinance

You’ll pay $6000 in closing costs today, save $80 a month for the next 3 years and then sell the home. All in all, you’ll pay about $3000 more than if you kept your existing mortgage.

Scenario 3: You keep this mortgage for right about the breakeven period

In a situation where you plan to keep the mortgage for only about the breakeven period,  different people can make different choices.

One group might say let’s do it because who knows your plans might change and you might keep the mortgage for longer.

Another group might argue the opposite and say, what if I sell the home or refinance sooner than expected.

For a scenario like this, a lot depends on your individual situation and preference. Some people like the flexibility and are willing to pay a little for that. Others prefer the savings over flexibility and choose to take the plunge.

Refinancing can be a great idea even if rates haven’t dropped much

For many people, refinancing may not yield any benefit at all if rates haven’t dropped much. But in quite a few situations, it may be a great idea. Following are some examples:

(1) Need a Personal Loan – Refinancing can be a very powerful avenue for those who need to borrow money for any personal use. 

How? Say your home price has gone up since you bought and you have more equity in your home. By doing a cash-out refinance, you can get cash as a part of the refinance.  

This cash can be used to do a renovation or for your kid’s college education or for any other purpose you want.

Since the rate you pay on this cash is the same as your mortgage rate, you can avoid taking the more expensive personal loans at much higher rates.

(2) Consolidate debt – Let’s say you have credit card debts and other debts that have very high interest rates. 

You can take a similar approach. Do a cash-out refinance against your home and pay-off the high interest debt. 

The total amount of borrowed money does not change. But you effectively start paying a much lower interest rate on that other debt.

(3) Get rid of mortgage insuranceMost lenders prefer a down-payment of 20% or more when you get a mortgage. 

But when you make a smaller down-payment than that, lenders often ask you to buy mortgage insurance. And that can be expensive.

If you are one of those and your home price has gone up, refinancing into a new mortgage can effectively be used to get rid of mortgage insurance if your loan balance is less than 80% of your home value.

People can pay as high as 1% on your mortgage insurance every year. There can be significant savings if you can get rid of it.

The bottomline

Depending on your situation, there are many different ways in which a refinance can help you save. 

The myriad examples and situations described above are different from each other. But the common binding thread is the savings it brings to everyone.

So whether you are trying to lower your monthly mortgage interest payment or pay off high rate loans, at the heart of it lies one or more net tangible benefits.

If you are not sure whether it’s right for you, apply at stemlending.com/apply . We’ll be happy to discuss your situation and guide you to the right decision. 

At Stem Lending, you can compare real-time rates from many different lenders in one place. At your convenience and in one place, with just one application. We pick the lender that’s offering the best deal for you and take care of the rest. Get started now at: www.stemlending.com/apply.

 

APR Disclosure:

NMLS#1648699 STEM Lending, Inc. Ph: 833-600-0490. (nmlsconsumeraccess.org). The Principal, Interest and MI Payment on a $300,000 30-Year Fixed-Rate Loan At 3.5% is $1,374.08. The Annual Percentage Rate (APR) is 3.663% with Estimated Finance Charges of $6,000. The Principal and Interest Payment does not include taxes and home insurance premiums, which will result in a higher actual monthly payment. The APR is calculated using the Actuarial Method.