The 30-year fixed-rate mortgage dipped below 3.5% a couple of days ago. (The 30-year rate has been gradually decreasing over the last year and the 15-year rate has been fairly flat in 2016.) So, this might be a good time to ask, “Should I refinance my mortgage?” If the current interest rate is lower than your existing rate, this is worth looking at.
As you begin to evaluate the benefit of refinancing your home loan, you won’t be surprised to learn that many of the decisions you make when taking out a home loan are similar to other investment decisions you make. For example, you’ll be thinking about interest rates, tax effects, risk tolerance and many of the other things you consider when making your non-real estate investments decisions.
Here are some of the decisions you’ll need to make as you consider refinancing your home loan:
- Does this make financial sense? You can use one of the online calculators to see how much you might save with a lower interest rate and what the effect of the closing costs will be. You’ll also want to look at the break-even time. For example, suppose your closing costs are $2,000 and that you’ll save $100 per month. Then, your break-even time is 20 months ($2,000/$100). So you should plan on staying in your home at least another 2-3 years for refinancing to make sense.
- On a related note, you’ll need to decide on the best way to pay the closing costs. There are three common options: pay out of pocket, include the fees in the new loan amount or have the lender cover the fees in exchange for a higher interest rate. Out-of-pocket makes the most sense if you plan to keep the loan for a long time. This is also when bundling the fees into the new loan can make sense. The higher interest rate option is best used if you plan a sale or another refinance in a few years.
- Do you want a fixed-rate loan or an adjustable-rate loan (ARM)? Your risk tolerance is certainly a factor here. Also, you’ll want to think about how long you’ll keep this loan. (This means how long you plan on living in this house or how long until you’re likely to refinance again.) It’s interesting that some conservative investors always go for a fixed loan even when they plan to move in a few years. This causes them to pass up the cheaper ARM loan even though it will be paid off before the interest rate resets. If you do go fixed rate, you’ll need to consider the term of the loan. Generally, the shorter the term, the lower the interest rate. Also, a shorter term reduces the total amount of interest you’ll be paying over the life of the loan. On the other hand, a shorter-term loan locks you into a higher monthly payment whereas you could take a longer-term loan and increase your monthly payments to retire the loan earlier without locking in a high mandatory monthly payment. Finally, some people like to have the term of their refinanced loan approximate the number of years remaining in their existing loan. (For example, if you originally took out a 30-year loan and have paid against it for 5 years, you might want the term of the refinanced loan to be 25 years.)
- If your home has appreciated, you’ll need to decide whether to take some of its value out. There are considerations here too. First of all, if you take out too much money, your interest rate will rise. Also there’s the consideration of what you’ll do with the money once it’s taken out. If you plan to invest it, you’ll need to look at the after-tax effect of the investment versus the after-tax effect of having it reduce the home loan. Finally, you may have an immediate need for the money such as medical expenses, college expenses, remodeling expenses, retiring high-rate debts (like credit cards) and so forth.
- People who are nearing retirement have a few special considerations. First of all, taking out a loan depends on your monthly income, so be sure to have the kind of loan you want before giving up your monthly paycheck. (By the way, this same logic applies to a home equity line-of-credit. You’ll want to set that up before you quit working.)
If you end up deciding to refinance your home loan, there are a couple of key pieces of information that you’ll need to get the process rolling:
- You’ll need an estimate of your current property value. You can get this through a realtor or by looking at home sales in your neighborhood during the last 3-6 months using Zillow.com or Redfin.com.
- You’ll need to know your current loan balance (this is the amount of principal left on your current mortgage). You can find this on your mortgage statement.
While refinancing your home loan can be very advantageous, you can see that there are quite a few important decisions to be made. Guidepost Financial Planning has helped many of our customers think this through and would be glad to talk things over with you too. Please visit our website or give us a call at 970.419.8212 so that we can discuss this important topic in a no-charge, no-obligation initial meeting.
This article is for informational purposes only. This website does not provide tax or investment advice, nor is it an offer or solicitation of any kind to buy or sell any investment products. Please consult your tax or investment advisor for specific advice.