The topic of mortgage refinance has been in and out of the news cycle for what seems like a decade or more. It hasn’t been quite that long, but there are definitely some homeowners who are on their fourth or fifth refinance within the last 10 years. Are they making sound financing decisions or simply chasing the momentum and fever pitch of historically low mortgage rates? I spent four years selling real estate and three years writing mortgage loans, and over that time, I saw people make a number of foolish decisions. That said, there are four main criteria that I consider when helping clients make the decision of refinancing their mortgage and none of the criteria are based on how many times they have refinanced or the recency of their last refinance. Let’s walk through each of the four to better understand when the environment is right for you and your financial situation.
How much will your rate go down?/How much will you save per month?
I list this first because, in my opinion, it is the most important component to the overall decision. That said, it isn’t the only component. I would caution anyone who only looks at rate to be careful because solely focusing on rate can lead to a bad decision. For example, if someone only has three years left of their mortgage, even a full 1% drop in rate may not justify a refinance. Comparing the terms of your existing mortgage to the proposed refinances and running the numbers is the only way to know for sure that the refi is a sound financial decision. This is typically the first thing that I do when helping a client analyze their mortgage loan options.
What is the total amount of closing costs for the new loan?
This one is often overlooked in the craziness of underwriting and gathering the necessary documents. However, it is critically important to determine if the numbers make sense. For example, if your refinance is going to save you $100 per month and the closing costs are $2500, then you will break even in 25 months. We, then, need to consider how long you plan to stay in the house. In this scenario, I would only recommend moving forward on the refinance if you are planning to stay at least four more years. Otherwise, the total savings is just not meaningful enough.
How does the new loan term compare to the remaining term of your existing loan?
This measurement can be deceiving in how it relates to your monthly saving. Let’s say you have 23 years left on your existing loan and you refinance into a new 30 year mortgage. The lower monthly payment is a result of the lower rate and the loan term adjusting back to 30 years. Therefore, even though your payment will be lower, it doesn’t mean you are actually saving that amount of money. Continually resetting your loan back to a 15- or 30-year term can become a vicious circle which leads to never actually paying off your mortgage.
What is the balance on your current mortgage?
Simply looking at the mortgage rate comparison will not give you enough information to determine if a refinance makes sound financial sense. If a mortgage balance is $50,000, we would need a sizable drop in the interest rate to justify the cost and effort as opposed to a $300,000 mortgage where a quarter percent drop in rate could absolutely justify a mortgage refinance.
In the end, it is imperative that a full and proper analysis be done before paying an application fee or locking a rate. Seek out the advice of a well established mortgage loan officer or your financial advisor and fully understand all of the loan options before making a final determination. This will ensure a sound financial decision.