With interest rates currently at historic lows, many homeowners, even those who have only recently closed on their home purchases, are considering the pros and cons of refinancing. Freddie Mac reported in August (2019) that the average conventional 30-year loan is just 3.6 percent and 15-year loans are at 3.05 percent – that’s nearly one full percentage point lower than just 12 months ag, and coming in close to the 2012 historic low of just 3.31 percent. (To illustrate just how quickly rates are changing, by the time this article as ready to publish on September 6th, 2019, they’d dropped even lower…)
Black Knight, a leading provider of MLS, homeowner, and mortgage data, estimated recently that over 9 million mortgage holders could be classified as ‘good refinance candidates’. For clarity, their definition of good candidates are borrowers with a 30-year mortgage with a maximum loan-to-value ratio of 80 percent and 720 or higher credit scores. (If you’re not sure what your current score is, you can get it for free from one of the three reporting agencies.)
Even with their somewhat conservative math, that’s a lot of folks who could potentially save a lot of money over the life of mortgage loans with a simple refinance. But is it all that simple?
Generally, the rule of thumb has been that refinancing makes fiscal sense if you will reduce the interest rate on your mortgage by at least 2%. However, even a 1% savings is enough to justify refinancing in some cases but there are a number of factors to consider when doing the math on a potential refinance.
Why Would You Refinance Your Mortgage?
People choose to refinance their existing home loans for a number of reasons including reducing their monthly mortgage payments (and potentially paying off the loan faster), reducing the length of the loan, or generating cash for planned expenses (home remodeling, debt consolidation, education costs, retirement, etc.) or emergency expenses (unexpected medical costs, the loss of a partner, etc.).
When Can You Refinance Your Mortgage?
The truth is, you can refinance a loan the day after you officially close on it – but it only makes financial sense to do so IF you will stay in the property long enough to recoup the costs to refinance.
How Much Does It Cost to Refinance Your Mortgage?
In short, the cost to refinance a mortgage is based on the interest rate, your credit score, the lender and the amount you still owe on your current mortgage. As was true with the initial mortgage you obtained when you purchased your home, a higher credit score will land you a better interest rate, and relatively lower payments.
On average, homeowners can expect to pay 2% to 3% of the loan amount to refinance a mortgage. The out of pocket expenses to refinance include escrow and title fees, lending fees, appraisal fees (yes, your property will need to be appraised again for current value), points, credit fees, insurance, and maybe taxes (if you’re taking cash out and don’t use it for updates to the home). (Click here for a glossary of what each of these terms means.)
Obviously, unless you save more than you’ll wind up paying in the new loan scenario it doesn’t make sense to refinance. Here are some calculations to help give you more insight (to discuss more in-depth and run the numbers for your specific situation, pick up the phone and give me a call 971-404-9844)
For the purpose of this article, we’re going to focus on the long-term cost savings that can come from refinancing a mortgage loan to a lower interest rate.
First, we need to look at the difference between your cash flow savings (what you’ll save each month in mortgage payments) and your interest savings (savings in interest payments over the life of your new loan). It’s important to note that each mortgage is different and calculations will need to be adjusted accordingly for each individual scenario.)
Calculating Potential Interest Savings:
Multiply your current remaining loan amount by your current interest rate and divide by the number of months in a year (12) to calculate the amount of interest you pay each month:
(Current Remaining Loan Amount x Current Interest Rate) / Months in year = Interest paid per month
($400,000 x 4.75% or .0475) / 12 = $1,583
Now calculate with your (potential) new interest rate through refinancing (your specific interest rate will be based on a number of variables – this is just an example for the purpose of this article):
($400,000 x 3.75% or .0375) / 12 = $1,250
Calculate the difference between the two interest rates.
Current Interest Payment – Proposed Interest Payment = Interest Savings
$1,583.00 – $1,250 = $333
The result in refinancing your interest rate down by just 1% on a $400,000 loan balance will result in a lower monthly payment of $333 or nearly $4,000 per year.
Now you need to find out if and when these monthly savings will break even with the actual costs of refinancing your mortgage. You do that by dividing the Estimated Closing Costs (In this case $6k) by your Interest Savings to arrive at the Break-Even Point.
$6,000 / $333 = 18 Months
In this scenario, it will take 18 months for you to recoup the cost of your refinance. If you’re planning to sell your home in the next couple of years, refinancing isn’t going to make fiscal sense for you at this time. However, if you’re planning to stay in your home for at least five to ten years, you’d save plenty over the life of your new, refinanced loan.
If you’ve been intrigued by the dropping interest rates but you aren’t sure if it makes money sense to refinance right now, give me a call or shoot me an email and let’s take a look – I’d love to save you some money. Yes, even if you’ve only closed on your house in the last year, it can still be worth taking a look to see how you’d pan out with a refi.
Let’s see if we can save you some money – give me a call now at 971-404-9844.