There’s a lot of hype about refinancing mortgages. You’ll hear, “Rates have never been lower!” or, “Refinance now to lock in your savings!” There are even special products like “streamlined” refinancing.
Like anything else, you need to determine if a refinance is right for you based on the specifics of your mortgage. Here are some guidelines to get you started:
The Break-Even Analysis
A refinance makes sense when you can lower your interest rate enough to pay for the closing costs before you plan to sell your home.
Here’s a simple example. If you have a $100,000 mortgage and you can lower your interest rate by 1% in a refinance, you’ll save $1,000 a year. If your closing costs are $3,000, it will take three years to break even on your refinance.
In general, a refinance is worth it if you can lower your rate by at least 2%. At that point, you’ll see real savings on your monthly payment.
Points, ARMs and Seconds
When you’re gathering quotes for a refinance, ask for a par quote or zero quote. That means the closing cost estimates will not include points or origination fees. Don’t pay these fees, which are simply pre-paid interest. The savings, if any, don’t justify the up-front expense.
If you have an Adjustable Rate Mortgage (ARM), Dave will almost always recommend you refinance into a fixed-rate mortgage. Even if you have to write a check to pay for the closing costs, it’s worth it to avoid the risk that your payments could go up when the rate adjusts.
A lot of homeowners with second mortgages want to roll it into their first mortgage with a refinance. Not so fast! If the balance on your second mortgage is less than half of your annual income, pay it off in Baby Step 2. If not, go ahead and refinance it with the first mortgage and pay it off in Baby Step 6.
Going from 30 to 15
When you buy a home, if you’re not paying cash, you should get no more than a 15-year mortgage. However, if you already have a 30-year mortgage and a good rate, you don’t have to go to the expense of refinancing just to get the shorter term. Just calculate what your monthly payment would be on a 15-year term and be disciplined about paying that amount.