I know a lot of you are wondering whether you should refinance your mortgage. You see all the news reports about record low interest rates and wonder if it’s worth it. Regardless if you are considering an FHA loan refinance, VA refinance, Conventional refinance or other loan types, the evaluation is the same.
Adjustable Rate Loans
But before I get into evaluating whether to refinance your fixed rate loan, let’s talk adjustable rate loans.
If you have an adjustable rate loan – typically called a 5/1 ARM (or 3 year or 7 year) – AND there is a possibility you will own the house longer than the term of your loan – you need to refinance.
Rates will not get lower than this and you need to lock it in now. Rates on a 30 year fixed mortgage (meaning the interest rate will not change and you have 30 years to pay it off) are 3.75 to 3.86% right now! Rates this low are unheard of in the past – well forever. Call a mortgage broker today. If you need recommendations I have a real estate license and know some good lenders – send me an email at firstname.lastname@example.org or leave a comment on facebook and I’ll send you a list.
Fixed Rate Loans
Here’s how to evaluate if you should refinance or not.
- Current Loan Balance x (current interest rate – new interest rate) = Savings per Year (slightly overestimates savings)
- Closing Costs (typically 1% x Loan Balance + $2000) / Savings per Year = How long it will take for the upfront costs to pay for themselves with your reduced mortgage payment.
Question – Will you be in your house longer than how long it will take to break even on the closing costs? If so, then it’s time to refinance.
- Don’t get fooled by the “no out of pocket expense” refinance option. That just means they are adding the closing costs to your loan balance. That still means you are paying for it and the evaluation is the same.
- Also, the prepaid escrow fees are not closing costs. If given a good faith estimate of closing costs, subtract the escrow monies out before you run the above calculation. You would pay those one way or another, they are just establishing an initial balance. When you refinance, your old bank will send you a check for the amount in your current escrow account – so these usually cancel each other out.
Scenario 1: Interest Ike has a current mortgage balance of 300,000 and an interest rate of 4.75% (thought to be a pretty darn great rate 18mo ago when they bought the house). With today’s interest rates of 3.75% does it make sense to refinance? **Interest Ike owns his dream house and does not plan to move within the next 20 years.
- $300,000 x (4.75%-3.75%) = $3,000 Savings per year
- Closing costs = $300,000 x 1% + $2,000 = $5,000
- $5,000/$3,000 = 1.67 years or 20 months
Since Interest Ike plans to live in his house longer than 20 months it makes sense to refinance.
These numbers are not exactly accurate as the loan balance will get paid off over the same time frame, so savings are not consistently $3,000, but it is close enough to make a decision. Then go talk to a bank and ask them to run the numbers for you and calculate the exact time for repayment of the upfront costs.
To get exact numbers use a free loan calculator.
Scenario 2: Same values as above $300,000 at 4.75% (but only 28 years left on the loan – original purchase price $310,000) versus new loan of $300,000 at 3.75% over 30 years.
- Keeping the current loan the total interest paid until paid off = $242,000. (monthly payment $1,617)
- Refinancing total interest paid until paid off (assuming not paying any extra each month) = $200,200. (monthly payment = $1,390)
- $5,000 closing costs/$227 monthly saving = 22 months to break even on closing costs
Assuming they continue to pay the same payment each month, total interest paid = $149,000
Total savings = $93,000 (minus $5,000 closing costs) = $88,000 saved.
Scenario 3: Same values as above $300,000 at 4.75% (but only 20 years left on the loan – note this means initial purchase price of home was $400,000) versus new loan of $300,000 at 3.75% over 30 years.
- Keeping the current loan the total interest paid until paid off = $176,614. (monthly payment $2,090)
- Refinancing total interest paid until paid off (assuming not paying any extra each month) = $200,165. (monthly payment = $1,390)
- $5,000 closing costs/$700 monthly saving = 7 months to break even on closing costs
If you only look at the total interest paid, it doesn’t make sense to refinance. However, using a free mortgage payment calculator, let’s assume they refinance and continue to pay the same payment each month (basically paying an extra $700 toward the mortgage each month).
Total interest paid = $97,436
$176,414 -$97,436 +$5,000(closing costs) = $84,000 savings
If this is unclear or you’d like me to run numbers for your specific situation, please don’t hesitate to ask!
**This is a sponsored post.