With interest rates at all-time lows the question often comes up if it is a good time to refinance my mortgage. For many homeowners it is a great time to consider this. But before rushing to your local bank to fill out an application there are a few things we want you to be aware of. Here are the top five do’s and don’ts when refinancing your home.
Don’t try to time the market
As interest rates fall it can be hard to know when the right time is to refinance your mortgage. Many homeowners are faced with a fear of missing out on the “best” possible rates. They continue to wait hoping rates will go just a little bit lower. Although it is only human to feel some level of regret if rates drop after you refinance, the cost of waiting is often greater. Trying to predict the direction of interest rates is extremely difficult and we encourage clients to consider whether it is right for them to refinance at each point in time without trying to guess where interest rates might go next.
Do a breakeven analysis
A breakeven analysis is used to estimate the time it will take to recoup closing cost with interest savings from refinancing. This calculation is done by dividing the closing cost by the interest savings. For example, a mortgage with $500,000 of debt outstanding refinanced from 4% to 3% would save 1% in interest cost annually. This would result in a $5,000 interest savings. If closing cost are $7,500 the breakeven calculation would be $7,500 divided by $5,000 resulting in a breakeven time of a year and half. If you plan to stay in your house longer than a year and half, then refinancing your mortgage could make sense. The example above is a basic illustration. More thorough analysis can be performed by your loan officer to get a clearer picture of the costs and benefits. When doing the analysis, it is important to take into effect only the interest savings and not the reduction in your monthly cost. A reduced monthly cost could be a partly due to decreased interest payments and partly due to an increase in the length of the loan.
Don’t re-amortize to a longer time period
It is often assumed that a mortgage is for 30 years, but this does not have to be the case and especially when refinancing. For someone that has been in their house for years and is looking to refinancing it can seem tempting to refinance with a 30-year mortgage because it will result in the lowest monthly payment. However, it is important to note that even when refinancing to a lower rate by increasing the number of years on your mortgage you might end up paying more in interest payments over the remaining life of the loan. Moreover, shorter mortgage terms typically carry lower interest rates when refinancing.
Do keep payments the same
Although refinancing can lead to lower monthly payments, we encourage homeowners to keep their payments the same. This can be done by decreasing the new mortgage length or by paying additional principal payments each month. The goal is to pay off the mortgage early. This can be especially beneficial for homeowners nearing or in retirement. Debt in retirement can be a serious drag on the income streams provided by your investments.
Don’t take cash out
One of the options for many homeowners thinking about refinancing is to take cash out of their home. This is typically considering when thinking about funding a home improvement. While everyone’s situation is different and this might make sense for you, we typically do not recommend taking cash out when refinancing. This is because doing so will likely mean you will increase the amount of time it will take you to pay off your loan.
We hope this article was helpful when thinking about refinancing. It is important to keep in mind that everyone’s situation is different. If you would like to talk about whether refinancing might make sense for you and how this fits into your broader financial picture please reach out to us at (816)364-4900 or by email at heritage@heritage-inv.com.