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When Does it Make Sense to Refinance?

Now that rates are falling again, our past clients often ask whether the rate is low enough to justify a refinance. The answer is: IT DEPENDS!

Many years ago, it was generally accepted that the rate needs to drop by 2% to justify a refinance. But that was when the average loan was less than $100,000. Today, our average loan is closer to $500,000, so a much smaller rate drop is enough to give you significant savings.

Here’s what you need to consider: Let’s assume you borrowed $500,000 on a 30-year fixed rate loan last year at 4.25%, and that your payment is $2,459.70 per month, and that your current balance is $491,570. Let’s then assume that you could lower the rate to 3.625% at no points, dropping your payment to $2,241.81 per month. That saves about $218 per month, $2,616 per year.

A no-brainer, right?  Maybe, maybe not. Before we can comment on the wisdom of this move, we need to ask you a few questions to understand your goals:

1.  How long do you expect to own your home? If you’re going to sell in a year, think twice before refinancing. In the example above, the closing costs will be about $3,000. You’d need to be in your house 13 months just to break even. Yes, you can roll the costs into the loan, but now you have a higher loan balance to pay off when you sell your home. Yes, you can choose a higher interest rate and have the bank pay all of your costs. Then you just need to ask yourself if the reduced monthly savings are worth the exercise. On the other hand, if you have definite plans to sell in 5-7 years, perhaps you’d be better off with a 5/1 or 7/1 adjustable rate mortgage at a lower rate.

2. How much savings is enough?  People ask me if the savings is worth it. I ask them “Is it worth it to YOU?” Everyone has their own opinion. To some, $100 a month is enough to justify the exercise.   Others can’t be bothered for anything less than $1,000 per month.  As one well-heeled client expressed “I spill more than that out of my cocktail glass at the country club every month!”

3. Do you want to lower your monthly expenses or do you want to get your loan paid off earlier? If you’ve already had your 30-year loan for 10 years, you can lower your payments by refinancing to another 30-year loan, but you’d add 10 more years of payments. So it’s useful to calculate whether the new rate is low enough to lower your payment and still pay off in 20 years. On the other hand, you can lower your RATE significantly with a 15-year loan, but your payments may be higher than what you’re paying now. 

4.Do you want to consolidate debt or get cash out?  Maybe you have a second mortgage at a high rate, a home equity line of credit tied to the Prime rate, or high-rate car loans and credit cards. You may able to significantly lower your rates and payments by consolidating them all into a single low-rate mortgage, but remember that you’re converting some short-term debt into 30-year debt. If you want cash to make home improvements or buy a car, a cash-out refinance may be the best bet. Many of my clients have extracted cash AND lowered their payment at the same time by refinancing.

5. Do you want to switch from an ARM to a fixed rate?  That’s a tough one. Rates on adjustable loans are very low, but for how long? Are you willing to pay a little more for a fixed rate if it protects you from the POSSIBILITY that your adjustable rate will rise in the coming years? Only time will tell if this is the right move. But if you have trouble sleeping at night because you’re worrying about rate increases, it may be worth it to switch just for the peace of mind.

Whatever your goals, you’re always welcome to call us at Finet Mortgage to kick some ideas around. There’s never a cost or obligation.


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