Should You Refinance Your Mortgage Now?
August 2, 2009 by Janet7
Many homeowners are considering taking advantage of today’s historically low interest rates by refinancing their mortgage. In many cases, they are able to save hundreds of dollars per month by refinancing. Whether mortgage refinancing makes sense for you can be easily determined by doing some simple math.
The first consideration is how much lower your new interest rate should be than your current rate. There is a common belief that if current rates are more than 1.5 to 2 percentage points lower than your current rate, then you should refinance. That’s a good starting point, but there is more to the story than just the raw interest rate.
Your real concern should be the total cost of the mortgage refinance both in the short term and the long term. The total cost includes not only the monthly mortgage payment (principal plus interest), but the closing costs, as well. Closing costs typically include such things as:
- Appraisal fee
- Credit Report fee
- Processing fee
- Commitment fee
- Tax Service fee
- Flood Certification fee
- Discount points (if any)
- Title Insurance (based on mortgage amount)
- Recording/Notary fee
- Per diem Interest
- Real Estate Taxes
- Home Insurance (percentage of mortgage amount)
Adding all these up can easily run into several thousand dollars, even without discount points. This is money that must be paid at the loan closing. In the case of a mortgage refinancing, lenders often advertise “no closing costs”, which is a bit misleading. The truth is that there ARE closing costs, but they are paid out of the proceeds of the loan rather than the pocket of the homeowner. This is possible when the homeowner borrows against the equity in their home as part of the refinancing.
As an example, let’s say that your home is worth $175,000. Your original mortgage was for $125,000 over 30 years at 7% interest. You still owe $100,000 on the original mortgage. The closing costs for your refinance are $3,000. If you simply refinance the $100,000 amount at a lower interest rate you will reduce your monthly payments, but you will have to pay the $3,000 closing costs out of your own pocket. If you choose the “no closing costs” option, your $3,000 closing costs will be paid by simply borrowing the additional money against the equity in your home (i.e. the value of your home less the amount owed). Your mortgage will now be for $103,000 instead of $100,000.
So, what about that widely held 2 percentage points belief we mentioned earlier? The monthly payment for a 30-year $125,000 mortgage at 7% interest is $831.63. For your new 30-year $100,000 loan at 5% interest, the monthly payment is $536.82, a savings of almost $300 per month. If the new mortgage is $103,000, the monthly payment is $552.93, still saving you over $275 per month. In this scenario, considering only the monthly savings, you would recoup your closing costs in as little as 10 months.
Sounds great, right? Well, there’s another factor you need to consider. If your original mortgage was $125,000, you’ve been paying on it for 152 months to get the principal balance down to $100,000. Therefore, you have 208 months left before the mortgage is paid off under the original terms. If you continue without refinancing, you’ll pay an additional $172,978 (208 months at $831.63 per month).
If you refinance your mortgage for the $100,000 you currently owe, you’ll pay on it for 360 months at $536.82 plus the $3,000 closing costs for a total of $196,255.
$172,978 <– payout without refinancing
-196,255 <– payout after refinancing
-$23,277 <– difference
In this case, by refinancing you will end up paying an additional $23,277 for the new loan over the original mortgage. This works out to about $775 per year, which may be acceptable to you in order to have the lower monthly payment now. You are the only one who can make that decision based on your personal financial situation. The important thing when refinancing your mortgage is to consider all the ramifications.
This is another of today’s money secrets that can help you get the most for your money in today’s lending market!
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Brian
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Hi Chris,
It almost seems like we're in the calm before the storm. I've got a future blog entry planned relative to increased payroll tax audits, something that's been very rare up to now, and is going to hit many small businesses who issue 1099's for 'employee' services' like a club.
As a way to generate new business, we've also started introducing a second opinion tax service, primarily targeted at businesses who 'trust' their current accountant or tax preparer, and have absolutely no idea except for how much tax they have to pay, whether the return was prepared competently, or whether it will trigger an IRS audit.
For a nominal fee (because if I did this for nothing, I don't know if I'd get any takers), we will review the business tax return(s), and essentially use our 20 years of experience to advise on the likelihood the return will get picked up for audit. On virtually every non-random audit we've done for a client, we've been able to identify the key trigger events for what made that return get picked up.
Thanks for your post,
Steve
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