By Peter Mastrantuono
With mortgage rates at historical lows, more Americans are considering refinancing their home mortgage. Refinancing can make good financial sense for a number of different reasons, including to lower monthly payments, shorten the term of the mortgage, convert from an adjustable-rate mortgage to a fixed-rate mortgage, or to access home equity to pay off debt, meet expenses or consolidate debt.
Refinancing Factors to Consider
Refinancing a mortgage comes with costs, such as an appraisal fee, title search, origination fee and various other smaller fees.
As a consequence, homeowners need to determine if the savings realized through obtaining a lower rate will be greater than the costs of the refinancing. The rule of thumb is that refinancing makes sense if the current mortgage rate is 1% or more lower than your current mortgage. However, to ensure a refinancing is financially sensible, you should make sure that you plan to stay in your home for the years it takes to recoup the refinancing costs.
Though refinancing may be a smart financial move, you should consider your motivation for refinancing, as well as your personal financial behavior. For instance, many individuals refinance to pay off higher interest debt (e.g., credit cards). That may, in some cases, be the right move, but if you continue to spend beyond your means and pile up new debt, you could end up in a worse financial situation.
Moreover, refinancing in order to retire high interest debt only makes sense if the interest saved is more than the interest paid over the term of the low rate mortgage.
For instance, if you have a credit card balance of $10,000 with an interest rate of 16% and pay it off in four years with equal monthly payments, you will have paid about $3,600 in interest. Consolidate that $10,000 loan balance into a 30-year mortgage at 3% and you will have paid over $5,100 in interest payments. As suggested by this example, refinancing to pay off higher interest debt may result in larger cumulative interest payments.
Another factor to consider is the “no-cost refinance”. There is no such thing. The closing costs described above are real and will have to be paid. In the so called no-cost refinance, those costs are either added to the principal amount of the mortgage loan, reflected in a higher mortgage rate, or a combination of the two.
The final factor to consider is whether rates will continue to drop and if waiting for lower rates is smart. Of course, lower is always better, but there is no guarantee that rates will move even lower. Like the stock market, it’s very difficult to buy a stock at its absolute low, but then that’s not how success is measured. If refinancing creates meaningful savings, then now may be the time to refinance.
To help you determine whether the numbers work, you should speak with a financial advisor. He or she can guide you through the math to make sure refinancing is a wise financial decision.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.