You may have heard me say on the Sweet Home Minnesota radio show that mortgage interest rates will be higher by the end of 2010 than they were in the beginning. You should check about refinancing your mortgage before they go up.
Should you refinance? Click here to have us perform a No Hassle, No Obligation, No Bull check up
How do you know if you should do it? There is no “one size fits all” answer about who it makes sense to refinance. Let’s look at the following things:
- why would you refinance
- when does it make sense to refinance
- what challenges stop people from refinancing when it does make sense
Why refinance? You would normally do it to accomplish one of four things:
- reduce your monthly payment by getting a lower interest rate
- shrink your monthly payment by consolidating two mortgages into one
- convert equity in your home to liquid money by getting a cash out refinance
- shorten the length of your loan
Any refinance requires you to have equity in your home (unless you are doing a special refinance with your current lender, who has some special powers provided by the Obama plan to refinance your loan even when you owe up to 125% of your home’s value). Numbers two and three require you to have more equity than the others because both are considered “cash out” loans and typically you can’t borrow more than 80% of the home’s value to do that.
Should you consider refinancing?
When looking at whether or not it makes sense to refinance I always look to figure out the financial benefit or “break even” point for my clients. When you are refinancing to shrink your payments it’s pretty easy to figure out. We look at how much your monthly savings will be and compare that to the costs of doing the loan. We want to see that you will “break even” within 2.5 years. “Break even” is the number of months it will take for the monthly savings to equal the costs of doing the loan.
Usually when refinancing two mortgages together or combining other debt like credit cards into the new loan the break even point comes sooner than if you are simply getting a lower rate on your current home.
I think reason #4 is a great thing to try to do. When rates are so low, if you can shorten the length of your loan and not change your monthly payment much you will normally benefit by savings tens of thousands of dollars in interest payments over the life of the loan.
One of the smartest things I ever did was shorten my loan. I refinanced my loan with 27 years left to a 20 year loan when it only increase my payment by $80 a month. Think about 7 years of a mortgage going away–if it was $1,000 a month you would save $12,000 a year and over the seven years I cut off my loan that would mean saving $94,000!
(Then we did a dumb thing and sold that house and built a new one at the very tippy top of the market in 2006. Oh well, even smart people can be fools…)
What might stop you from refinancing?
Assuming the “break even” point fits in that 2.5 year time frame I mentioned, there are still reasons to not refinance.
Right now, the most common reason people in Minnesota don’t is because they don’t have enough equity to pull it off. Maybe they could do the refinance, but the new loan would have Mortgage Insurance (MI). It usually doesn’t make sense to add this expense to your loan if you don’t already have to pay it.
We also need to consider how many years you are adding back on to your loan–for example if you only have 20 years left on your loan it may look like it makes sense to refinance in terms of monthly payment savings. But, when we consider how many more years you will have to pay on the loan it may not make sense.
The last thing to consider is how long you think you will be living in your home. If you might be moving before you would hit your break even point, then you usually should not pay all those closing costs if it’s quite possible you won’t have enough months at the lower payment save enough.
What Should You Do?
The only way to know that really is to get an individual analysis of your situation. Send me an email using the boxes below with some basic info about your situation and I’ll follow up with you to help you decide what your options are.
Remember–the Federal bailout of mortgage rates ends in March. Rates won’t jump up a lot immediately, but they are way more likely to start jumping around now that there’s not $1.25 Trillion dollars being pumped into keeping rates low.
