When is refi worth it? Mortgage interest rates are at historical lows. But if you bought at interest rates a point or two higher than they are today, will you automatically save by refinancing? Not necessarily. Here are our best money-saving tips on when to refi your mortgage… and when not to.
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Mortgage interest rates have been all over the board since your parents were your age. In 1981 the mortgage interest rates hit an unprecedented high of 18.5% for a 30-year loan. It decimated the housing market.
In contrast, mortgage rates of 5% or less are dream bargains. Today’s rate (August 10, 2020) of just 3.125% isn’t just a bargain – it’s a screaming bargain. It has set the housing market on fire. And people are racing to refinance their mortgages. But should you?
Contrary to popular opinion, locking in a lower interest rate doesn’t always save you money. Here’s essential intel on when is refi worth it… four reasons to refinance – and what to know about each before forging ahead. Plus, three cases when it may not be smart fo refi your mortgage. First, when is refi worth it?
When is Refi Worth It? 4 Reasons to Proceed…
1. Refi your mortgage to cut your interest rate.
This seems like an obvious no-brainer. In September 2019, estimates were that more than half of all borrowers with a 30-year fixed rate mortgage could save at least ¾ of a percentage point on their interest rate. But just locking in a lower interest rate may not be a strong enough reason to refi your mortgage. We explain why below.
2. Refi your mortgage to replace an adjustable rate mortgage.
Today’s low rates leave little wiggle room to go lower, but plenty of room to rise. That means refinancing might make the most sense for borrowers with an adjustable-rate mortgage (ARM). ARMs are susceptible to rate hikes once the loan’s initial fixed-rate period expires. So locking in today’s low rates with a fixed-rate mortgage (and a binding interest rate) can help protect you from future rate hikes that could lead to higher house payments and a greater risk of losing your home in the event of a crisis.
Still, fixed-rate mortgages usually come with higher interest rates than ARMs – which could mean a higher monthly payment, at least initially. That means it’s a good idea to weigh your expectations about potential future rate hikes against the peace of mind that comes from locking in a lower rate for the life of the loan.
3. Refi your mortgage to oust your PMI (Private Mortgage Insurance).
Lenders require PMI when you make a down payment of less than 20%. If that’s you, it may be possible to eliminate that expense by refinancing. But that’s not a foregone conclusion.
First, if you believe your home value has risen to the point where your equity stake is above 20% and the loan value below 80%, you’re no longer required to carry PMI. Doesn’t matter if it’s because you paid that much into the loan or that you’ve enjoyed rising home values.
If you have at least 20% equity in your home, ask your bank for a reappraisal. The law requires lenders to drop your PMI payment once your loan value hits 78% of the total value of your home’s original value. But they can be slow to act, and it’s your dollar. How close are you to your PMI disappearing? If you’re close, is refinancing still worth it?
4. Refi your mortgage to pay off more expensive debt (very cautiously).
If you’re carrying substantial amounts of high-interest debt, you could consider a cash-out refi – which allows you to borrow extra funds against the value of your home. Using low-rate funds to pay off high-rate debt can be a smart strategy. But there’s also danger…
3 Times When Refi is Not Worth It
A lower monthly payment may be your goal. But a refi could actually cause you to pay more – possibly a lot more – over the long run. It’s important to do a thorough cost-benefit analysis before you talk with a lender. Here are three key reasons you might want to just say no.
1. You plan to move in the next few years.
Finance professionals typically advise against buying a home unless you’ll stay in it for at least five years. The same holds true for refinancing.
You incur appraisal, recording, and other lender closing costs when refinancing – so you should consider whether you may be moving in the next few years, for whatever reason.
Of course, you can’t anticipate every circumstance. But if you may start a family, take a new job, or move closer to extended family, you’ll want to know where your break-even point is.
If your job is insecure, you may be better off sticking with your current loan where you have a loan history and skip the loan fees right now. Because if you can’t make back your closing costs and other fees by the time you sell, refinancing your mortgage just isn’t worth it.
Secret Way to Lower Your Payment Hardly Anyone Knows About
Some lenders allow you to “recast” your mortgage after paying a large lump sum. The interest rate and terms stay the same, but they set a new amortization schedule based on a smaller balance.
This lowers your monthly payments for the remainder of the loan, giving you an instant cash flow surge. But you need the cash to make a qualifying lump sum payment.
VA and FHA loans are usually not eligible for this option.
2. The mortgage interest rate cut isn’t large enough.
If the difference between your original loan rate and the current rate isn’t big enough, it’s just not worth it to try to refinance. A key stat you need to know is the total interest paid out over the life of the loan.
In the case of a refi, add the interest paid to-date on your current loan, plus total interest due on your refinanced loan. Compare that number to the total interest paid if you stay with your current mortgage.
In a hypothetical example on Bankrate.com, refinancing just the outstanding balance of what was originally a $400,000 loan (paid down to $317,886), with an interest cut from 4.25% to 3.5%… You’d still pay a whopping $41,375 more over the life of both loans by refinancing. And that’s with a ¾ percentage point decrease. It can take a lot to move the needle. Ask yourself: Wouldn’t that $41,375 be put to better use in your retirement account?
3. You’re more than a few years into your current mortgage.
Even if you plan to stay put for a while, consider how far into your current mortgage you currently are. Let’s say you’re 10 years into your 30-year loan and you refinance with another 30-year loan. You just added another 10 years to the time you’ll pay on your loan.
To justify another 10 years of payments, you have to save a huge amount of money on your monthly mortgage payments. Or else commit to repaying the loan much faster than required.
When to Refi Your Mortgage: Run Your Own Numbers… Don’t Take a Lender’s Word for It
Bottom line… don’t rush off to refi your mortgage unless and until you’ve done all your homework. And you’ve run your own numbers. Lenders will try to entice you to refinance your loan with all sorts of offers. Like no closing costs. (Who do you think is paying those costs? You’re being charged for it somehow. They aren’t paying for it out of the goodness of their hearts.)
Don’t automatically assume refinancing is a good deal. And don’t automatically assume that you’ll get the rock-bottom lowest rates offered today. You might if your credit is terrific and your debt load is low. Otherwise you might not.
Lastly remember, just because it’s a good deal for your buddy or a family member doesn’t automatically make it a good deal for you.