Is Now a Good Time to Refinance?

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!

Is Now a Good Time to Refinance?
Is Now a Good Time to Refinance?
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…

Closing Costs

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.

Loan Term

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.

Declining Equity

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?

( Photo courtesy of rossgram )

13 Responses to Is Now a Good Time to Refinance?

  1. No Refi’s for us, we locked in at 4.875% when we closed on our new house in January! When we started building in August I didn’t think we’d see a rate below 6, but to my delight we got under 5%! Good post and reminder to run the numbers and don’t just jump into something without figuring out what’s best!

  2. 4.875%? Looks like you’re fixed for life! You may also have purchased a house at one of those rare times that offers both low prices and low interest rates.

    Some people have all the luck!

  3. Hmm. I’m a little bit confused on the element of mortgages. Couldn’t you pay back a mortgage in lump sums when you wind up into a surplus of cash?

    Refinancing a mortgage is a definite maybe. It could improve cash flow, but prolongs the debt. So it ultimately comes down to a very mathematical decision on a rather individualistic degree.

  4. Aury, you’re raising a good point, one I’ve made in other posts. Though periodic mortgage prepayments are easier to manage for most people, once money is paid into a mortgage it’s lost until the loan is fully paid and the benefit is realized.

    It’s my opinion that most people would be better served by maximizing their savings each month, building up the account steadily, then making lump sum payments when the account gets beyond a certain level (which will vary with the person).

    By sandbagging the mortgage prepayments, you hold on to your liquid cash until you’re certain you don’t need it. But then I’m a liquidity guy, and many would argue in favor of monthly prepayment.

  5. Refinancing can certainly make sense because a lower interest rate means lower monthly payments, and ultimately a lower total cost. But is the decision to refinance really that simple? Unfortunately, there’s more to a refinance than simply deciding to go ahead with it and get a lower rate. If you aren’t careful, you could actually find yourself in a situation where the refinance ends up actually costing you more money. So, find out if your situation makes refinancing a good idea, and if not, learn how you can make a mortgage refinance pay off in the future.

  6. Hi, I have been struggling with whether to refinance or not. My home was purchased in 2007 for $200,000 with a 6.125 APR interest rate. I have been offered a 5.125 APR to refinance for 30yrs with $2200 in closing costs or 4.99 $2034 in closing costs though I owe $193000. I am in the 25% tax bracket and single, and wonder if I get a better tax break by keeping my interest rate where it is at to reduce my taxable income with the mortgage interest, as opposed to refinancing and restarting the loan at 196,600? It will take a year to break even from the closing costs increase, and I am not sure if I will stay in the house for 2-5 years. Please help!!!

    Thank you,
    Carmela

  7. Hi Carmella–You may get different opinions, but my thinking is that if you plan to move in 2-5 years, there’s no point in refinancing. You’ll reset your loan to 30 years, incur at least $2000 in closing costs, and raise your loan amount from $193,000 to $196,600 (I presume closing costs and escrows are included in the new loan?). You’re doing all this to save maybe 1% on the rate–which will be reduced by your tax benefit–for perhaps as little as 2 years. Again, just my opinion, but I wouldn’t do it. There’s too much cost for too little benefit.

    How sure are you that you’ll only be in the house for 2-5 years? Do you have enough equity to sell without having to write a check at the closing table? Or is that why you’re planning on waiting 2-5 years, in the hope that the property value will rise? If that is the case, my recommendation would change to go ahead with the refi. We can’t know with any certainty that the value will be higher in a few years. If it isn’t, you’ll be stuck at 6.125% when you could have done better.

    If you do the refi, consider setting a 26 year term on the new loan, rather than recasting at 30, so you aren’t just saving money on the rate and payment at the expense of a longer term.

  8. I have a 184,000 loan and my home is worth 325000 ( never tok cash out of home only refinance for lower rate, the house cost me 193000 at 5 percent). I am at 5% but I am thinking of refinancing at 4%.. this take $50,000 off the over all 30 year loan. is it worth doing the Va streamline if I am not incurring any closing coast or fees? It also reduces my monthly payment by 146.00

  9. My husband and I are contemplating refinancing. We have $107,890 left on our mortage at an interest rate of 4.25%. We had refinanced in 2004 to a 15-year loan so we are halfway through paying off the house. Would it be lucrative for us to have more cash flow by refinancing to another 15-year loan at this stage or are we better off paying down the house and being mortage-free in 7 years? Any help will be so appreciated.

  10. Hi Ayoma–If you’re halfway through, that means you only have 7-8 years left to pay. If you could get the mortgage paid off altogether, that would REALLY help your cash flow. If you’re going to refinance, and you want a lower interest rate, refinance into a morgage with the same term you have remaining on the loan (7-8 years). If you’re that close to paying it off, I’d go for paying it off, rather than recasting into 15 years. In today’s uncertain economy, anything you can do to get out of debt is a plus.

    The one exception is if you’re struggling to pay the monthly payment, and recasting would enable you to survive and keep the house.

    Of course, this is just my opinion based on the most obvious factors. You need to consider your age, income stability, and future plans, among other factors, to determine what you should do. You also have to factor closing costs for the refinance into the mix–they’ll most likely increase your mortgage balance. My advice would be to talk to someone who knows your situation but can be objective.

    There’s a lot to consider here, and I’m giving the opinion of a person who doesn’t know the details of your life. Think long and hard about this because what ever you do, you’re giving something up to get it. Good luck!

  11. I want to pull about $50K cash out of my home. I only owe about $110K currently and already have a 15 yr mortgage @3.5% which I just refinanced into in the spring of 2012 however, at that time, I did not take any cash out and new need it. Interest rates today don’t seem much better than I already have but I do need the cash or rather want the cash to make some other investments that I can hopefully earn a good return on. Is it wise of me to refinance right now? My only costs would be the appraisal fee nothing else! Not even escrow fees a s the lender is giving me credits to cover them. My new loan would be another 15 yr fixed at 3.625, a bit higher than I currently have but with $50K cash out to make other investments, same 15 yr term and no closing costs other than the appraisal fee of maybe $450.00.
    My monthly payment will go up by about $300.00 which does make things a little bit tighter for me budget wise but is doable and the value of getting that additional $50K at such a low interest rate for me, is well worth the extra $300 per month in payment. I plan use that money to invest in a smaller, less expensive and less upkeep property to live in while keeping my current home and renting it out forever.
    I do not intend to sell this property at all.

    So, my question is… should I refinance to get money out…. or stay put, forget about downsizing or making other investments and just work on paying my current mortgage off as fast as possible?
    Note….I am a single woman, 45 years old.

    Thank you so much. Any advice will be greatly appreciated.

  12. Hi Shannon – I don’t know enough about your overall financial situation, including income (amount or reliability) or non-housing debt to give a definitive answer. I will volunteer this however…as a single 45 year old, I’d be a bit cautious – there’s no backup income source. Also, I’m not particularly fond of borrowing even for additional investments. If the real estate market takes a hit (like it did a few years ago) you’ll be even more exposed to loss.

    Also – this is just me – I don’t completely trust this economy. It seems to be held together with tape and glue. For example, we have these super low interest rates – what happens if they go up a few points? It won’t be good for housing or the economy. I know several people right now who are having difficulty selling property even with these low rates.

    That may not be the answer you were looking for, but it’s the best I can do with limited information, and a very questionable economic outlook.

  13. Hi Kevin,

    AWW… Darn.. Yea, you are right… though that is not exactly what I was “hoping” to hear, you certainly do bring up many very good points to consider. It sounds like I might want to put a bit more thought into it before making any big moves. Thank you

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