Rates for fixed rate mortgages are below 4% for a 30 year loan, and down close to 3% for 15 year loans. So is now a good time to refinance? Maybe. And only maybe.
If you have an adjustable rate mortgage (ARM), a funky ALT-A, a variable home equity line of credit that can be consolidated, or most definitely a sub-prime deal, refinancing is a no-brainer. You’ll probably get better terms and a much better rate, so do it and don’t delay. No one ever needed a six month, interest-only ARM with negative amortization in the first place!
It’s not all about rate!
But if you refinanced or purchased your home during the last rate bonanza, and have a fixed rate loan in the 6% range, you really have to do some number crunching to see if it’s worth it. Refinancing isn’t a contest to get the lowest rate possible. You have to determine if a refinance works within the parameters of your own personal circumstances. Sometimes, refinancing can even be a step backward!
If you do refinance, do a thorough job and compare mortgage rates carefully. It really isn’t all about rate as some lenders who advertise very low rates charge very high closing costs and can find other ways to make you pay for your low rate.
Some reasons you may NOT want to refinance, even at these historically low rates…
Spending $5,000 for closing costs to get a $50/month advantage will probably be a step back for most. The recapture period on that will be 100 months ($5000 divided by $50 per month in savings), or greater than eight years.
A common rule of thumb in the mortgage industry has traditionally been a two year recapture period. A refinance might make sense if the recapture is longer than that, but two years is realistically the outer range of predictability, after which crystal balls tend to fog up.
Statistically, most people don’t carry a mortgage for more than 5-7 years before selling or refinancing again–factor that into the projection even if you’re certain you’ll be in the house for 20 years. The reality of life is that circumstances do change, so it’s best not to assume permanence. Think about how many times you’ve moved or refinanced in the past 10-20 years–that’s your reality.
If your current 30 year mortgage has 25 years remaining on it, you’ll reset the loan to 30 years by refinancing, which puts you back at square one. Might that affect your retirement plans?
You could get around this problem by making the new loan a 25 year term instead of a brand new 30 year term. On a $150,000 mortgage at 4.75% however, this would raise the new payment from $782 per month, to $855. In my many years in the mortgage business I can tell you that the human tendency is to opt for the lower payment in 90% of refinances. After all the numbers are crunched, most people refinance to improve their cash flow. But long term, cash flow isn’t improved if an extra five years are added to the back of the loan.
An Uncertain Future
Life just isn’t as stable as it once was. Jobs come and go, career changes are no longer unusual, the divorce rate is embarrassingly high—all of these changes often require mobility. Under closing costs above we talked about the recapture period on closing costs, but it rates another discussion here.
Mortgage financing is long term in nature, so it’s not possible to consider it in a vacuum that assumes perfect world conditions. How stable is your job? Is a transfer or job loss a distinct possibility in the next couple of years? If you were to lose your job, could you replace it with a comparable position in the city where you live, or would the loss require a geographic move? Is the likelihood of a move a real possibility in the next few years?
Compare the closing cost recapture period to that time horizon; no matter how low the rate, it isn’t worth having if you won’t be in the house long enough to get a benefit from it.
If you had a loan equal to 80% of the value of your home when you bought it, but the value has dropped and a refinance would mean a new loan equal to 90 or 95% of the value, you will have to pay mortgage insurance on the new loan. This is the equivalent paying a higher interest rate, but in many cases, the additional payments won’t be tax deductible.
Unfortunately, it gets worse.
Mortgages today are priced based on risk. A 90% loan is considered to be a higher risk to the lender than an 80% loan would be, so there is a higher rate for the 90% loan. The rates you see published are for the best credit risks; as your profile departs from perfect, the rates go up. It’s possible you won’t get anything close to the rates you see published.
Your Remaining Term Is Below 15 Years
This is especially true if the remaining term is 10 years or less. The shorter the remaining loan term, the less rate matters and this is because principal repayment makes up the bulk of the payment.
Now may be a good time to refinance, but there may be an alternative
If refinancing isn’t a practical option, or if your equity or some other factor has declined to the point that a refinance won’t be available, consider putting any closing cost money you would have paid for a new loan into the existing loan, and work on accelerating the payments. How much could several thousand dollars paid into your mortgage now shave off the term of your loan?
As stated above, the lower the mortgage balance, the less interest rates are a factor. Ultimately, the goal with a mortgage is to get it paid off, so if a refinance won’t work in your situation, go back to Plan A, and work on paying the loan off.
Are you considering refinancing? What advantages or obstacles are you running into?