Time to Refinance Again?

Over the past few years mortgage rates have been hitting new lows, enticing homeowners into refinancing their loans for a new lower mortgage rate. Just over a year ago, 30 year conforming loan rates were around 5.00% and 15 year conforming rates were around 4.25%. Mortgage rates today on 30 year loans can be found as low as 3.50% and 15 year rates as low as 2.75% – almost half of the previous year’s lows.

Is now the time to refinance again to a lower rate? There are a few factors to consider when refinancing. You have to decide if refinancing makes financial sense overall even if you can get a lower interest rate.

The conventional wisdom when refinancing is getting a refi rate at least 1.00% lower than the current rate on your loan. You should also consider how long you’re planning on staying in your home.

Another important factor to consider is how far you’re into paying off your current loan. The longer you have had your current loan the more principal and less interest you’re paying each month, this is the amortization process which works like this.

For the first several years when you pay your monthly mortgage most of the payment goes towards reducing the interest on the loan and less goes towards reducing the principal. As each month goes by less of the payment is paid towards interest and more is paid towards principal. In the last several years of a loan most of the payment goes towards principal.

Refinancing basically ‘resets’ the amortization schedule and most of your payment goes towards interest again since you’re starting a new loan. If you just got a loan or have refinanced in the past few years you don’t have to worry about the amortization process since most of your payment is still going towards interest.

The costs involved when refinancing can run several thousands of dollars. You can easily see how much money you save each month by refinancing to a lower rate but you should also consider the fees.

When refinancing, figure out how much the closing costs (with points) add up to. Then take that number and divide it by the amount you think you will save on each monthly payment. Here’s an example: If your closing costs add up to $3,000, and your monthly savings are going to be $150 a month, it will take you 20 months to break even on the refinance.

In the example above if you plan to stay in the home for more than 20 months it pays to refinance. Besides the costs, refinancing also involves a lot of work on your part like providing the lender all your financial information needed. Just think back to what was involved getting your original loan, not an easy process.

Even if you will save money figure out if it’s worth the hassle. Most of the time it will be because getting a lower rate can save you thousands in interest payments. Better yet, see if you can refinance to a shorter term loan. Instead of refinancing a 30 year to another 30 year refinance to a 15 year loan. The interest rate will be even lower and you’ll save a ton of money in interest plus you’ll own your home in half the time.

You might also start the refinance process and discover you don’t have enough equity in your home to refinance or you might have less than 20% equity. Most lenders these days will require you to have at least 20% equity in the home. Even if you find a lender that allows more than 80% financing you’ll have to pay private mortgage insurance which might cancel out any savings when refinancing.

Before you rush out and contact lenders figure out if refinancing actually makes financial sense for you.

 
Author: Brian McKay
May 8th, 2012