As a homeowner, you are probably inundated with offers to refinance your current mortgage. Like most of us, you usually just discard those mass mailings along with all of the other credit card and junk mail offers.
But have you ever wondered if you should refinance your home?
Just like buying a home, refinancing can be a daunting and confusing process. However, refinancing at the right time and with the right terms could save you thousands of dollars in the long run. On the other hand, an ill-advised refinance could tack on years to your current mortgage and cost you thousands in out of pocket expenses.
Think about it this way, mortgage lenders are not in the business of saving you money. They are for-profit entities and the system is designed for them to become profitable–not you. These companies spend thousands on advertising and understand the market and this process far better than the average consumer. Before you take the plunge, ensure you’ve done your due diligence.
Prior to contacting a lender and diving head-first into this process, do a little research. Find out what the average Annual Percentage Rate (APR) for home mortgages and mortgage refinancing is. The APR is the interest charged for borrowing money –or the cost of the loan. For mortgage loans, excluding home equity lines of credit, it includes the interest rate plus other charges or fees. For home equity credit lines, the APR is just the interest rate.
|Conforming and Government Loans|
|30-Year Fixed Rate||4.538%|
|30-Year Fixed-Rate FHA||5.552%|
|30-Year Fixed-Rate VA||4.546%|
|15-Year Fixed Rate||3.852%|
|5/1 ARM VA||3.486%|
|Jumbo Loans—Amounts that exceed conforming loan limits|
|30-Year Fixed-Rate Jumbo||4.381%|
|15-Year Fixed-Rate Jumbo||4.152%|
|7/1 ARM Jumbo||3.953%|
**Rates, terms, and fees as of 3/10/2017 and are subject to change without notice.
How does your current interest rate compare? If your APR will not be reduced by at least a full percentage point, refinancing is not going to be beneficial for you—unless you are seeking to move from an adjustable rate mortgage (ARM) to a fixed-rate.
Let’s say you purchased your home in 2007 and the original purchase price was $250,000 at an APR of 4.85 percent (fixed rate). Your refinance preapproval APR is 3.75 percent for a 30-year term and you currently owe $222,000 on your home. We will estimate closing costs to be $6,000 (which is the current average).
You simply plug those numbers into the calculator and instantly you have a fairly accurate gauge to help you determine if refinancing is a good idea and how long it would take for you to actually begin seeing the savings.
According to this example, you would save just over $40,000 dollars over the lifetime of this loan. However, it would take approximately 2 years for you to break even and recoup all of the closing costs.
The original cost of your home purchased in 2013 is $325,000 at an APR of 4.009 percent (fixed). The refinance loan amount is $315,000 at an APR of 3.65 percent for a term of 360 months (30 years) with $6,000 in closing costs.
In this example, your total savings over the life of the loan is $21,494 but it is going to take you 54 months—nearly five years just to break even. Add to that the fact that you have already made plans to sell within the next five to seven years. In this case, even though you will save money long term and your monthly payments would be lowered, refinancing may not be the best financial option for you.
You have to have enough equity in your home in order to refinance which is determined through an appraisal of the home. You qualify for refinancing based on your property’s loan to value ratio (LTV). This is calculated by comparing the current market value of your home to what you owe. An 80 percent LTV is considered the magic number and is necessary for refinancing. Unfortunately, you must actually submit the refinance loan application and pay the associated fees—which could be hundreds of dollars– in order to determine if you are even eligible to refinance your home. Here are a few things that can help you estimate your LTV:
Now that you have done the math and have an idea of your home’s LTV, let’s move on to some other things to consider before making the final decision concerning refinancing.
Here are some of the overall benefits of refinancing:
“In most cases, it makes a lot of sense to pay money to bring down the interest rate. Paying three points, for example, could lower your interest rate from 4.25 percent to 3.5 percent. (Points are fees. One point is equal to 1 percent of the loan amount, so one point on a $200,000 loan would be $2,000.) Over years, that could shave way more than you paid in points off your balance. “It’s a huge difference, much, much larger than you would think,” Fleming says.
These fees are usually bundled together and are labeled closing costs, which can be paid upfront or rolled into the loan (some FHA and VA loans do waive some of these fees). When financing companies advertise “no closing costs” what they mean is there are no upfront closing costs—you will pay them, the question is when?
“If you take out $20,000 in cash on your 30-year mortgage to remodel your kitchen, you’re actually paying for that kitchen for 30 years. You may have to make some of those improvements two or three more times before you’re finished paying off the first round. You’re financing a paint job for 30 years.”
When deciding if refinancing is a viable option for you, try to focus on the big picture. Consider the new loan’s term length and total interest; the break-even time, your overall plan for repayment, your credit history and financial situation and your long-term plan for your home. Refinancing can create substantial savings long term when done correctly but could be financially devastating if entered into ill-advised.