When interest rates on home loans are extremely low, does that mean you should refinance? At what point should you do it? It's not always obvious because getting a new loan isn't free. There are costs that must be absorbed by the homeowner.
You need to consider the change in interest rates, the length of the loan, and the closing costs. It's simple math after that.
These are the basic factors to consider:
- How much have rates dropped vs. your current loan? Keep in mind that if you borrowed $750,000, a one percent decrease in the interest rate is likely to mean more than if you only borrowed $40,000. Look at the change in your payments and calculate how much you will save long-term.
- How long is the loan term? If you only have five years left on your mortgage, then it won't matter as much as if you have 27 years left. It's possible you might lose money in the first case and make out extremely well in the second. Again, look at how much you will save each month vs. the expense of obtaining the new loan.
- Could you handle a shorter term now? Consider that you might be able to handle a shorter period of time now. If you can reduce your current loan from 23 years to 15 years, there might be a lot of savings there. Even if your monthly payment doesn't decrease, you could still save a lot by making payments for 8 years less.
- What are the closing or acquisition costs? The banks charge you to borrow their money, and we're not talking about just interest. There are fees for credit checks, appraisals, origination fees, and much more in a mortgage refinance. Find out these costs from your lender and include them in your evaluation process.
The key is to compare your current loan and associated payments to the new loan's payments and the costs to acquire that loan. Remember to include the length of the loan in your calculations.
- Closing costs: Some banks have outrageous closing costs on refinance loans. Be sure to shop around before you borrow the money. Banks can vary dramatically on closing costs.
- Be cautious about getting a longer term. Some people get excited at the prospect of stretching out the loan to get even lower monthly payments. The equity in your house is going to build much slower. A smaller monthly payment isn't necessarily a savings if you have to make a lot more of them.
- Be wary of rolling the closing costs into the loan. This reduces your equity, but it does make it easier to afford the loan. The only problem is now you're also paying interest on all those costs, too. The bank loves it, which means you should not. You could be paying interest on those closing costs for 30 years!
Now you have some idea on how to evaluate your situation to determine if it would benefit you to refinance your mortgage. Compare the payments and the cost associated with getting the new loan. Look at the possibility of getting a shorter term, too.
Reducing your expenses is a significant part of improving your financial circumstances. Paying less interest for your mortgage loan could save you many thousands of dollars. The only way you can tell is to do the comparison. So pull out your calculator and run those numbers. You might be very pleasantly surprised! At Pink Door Management, we can assist you from start to finish. If you are looking at using your home as an investment property, be sure to check out our FREE rental analysis so you will know what you're property can potentially earn as an investment home.