Should You Refinance...Again?
With mortgage rates nearing all-time lows, here are key points to consider as you weigh housing costs and retirement savings goals.
Lauren and Dave Falcone purchased their Canton, Mass., colonial in 2005, taking on a 30-year fixed-rate mortgage at 5.25 percent.
They refinanced their mortgage in August 2010, locking in a nice 4.25 percent rate on a 15-year fixed-rate loan.
But now, a year later, mortgage rates are flirting with -- or at -- all-time lows. The Falcones are thinking about refinancing again.
"If I refinanced now, I could save $171 a month on the mortgage," says Lauren Falcone, 40.
But unless they go for a shorter-term mortgage, refinancing would reset the clock on their payments. That's a concern, because the couple would rather not have a mortgage hanging over their heads when they retire. Falcone says she inherited her grandmother's "Don't be in any debt" mentality, which she says gnaws at her psyche, but today's historically low rates make a refinance very tempting.
Here's what you need to consider before you sign on the dotted line:
1. Figure Out the Real Costs
Mortgage rates on 30-year loans averaged 4.17 percent last week, according to BankRate.com. Loans lasting 15 years averaged only 3.45 percent. That's some cheap money.
"It is a good time to refinance because of the low interest rates," says Marc Henn, a certified financial planner with Harvest Financial Advisors in West Chester, Ohio. "In this environment, you want to look for a fixed rate -- not variable -- and lock it in for the life of the loan."
Henn says he typically likes to see a difference of at least 3/4 percent on the interest rate, but really, the decision rests on far more than the rate.
If you plan to stay in your home for a relatively short period of time, the closing costs could make the lower interest rate moot. You need to stay in the home long enough that your monthly savings will allow you to recoup the money you laid out for the closing costs -- your break-even point.
Here's some simple math to illustrate the point: Say your refinanced mortgage will save you $100 per month, but you have to pay $2,000 in closing costs. It will take you 20 months to recoup those costs in mortgage payment savings.
"If you plan on staying in your home for fewer than 20 months, then it doesn't make sense to refinance," says Margaret O'Meara, a certified financial planner in Red Bank, N.J. "Conversely, if you stay in your home for at least three years -- 36 months -- your savings over those three years is $1,600 if you refinance."
If you plan on staying in the house a long time, say 20 years or longer, then even a small interest rate change, such as 1/2 percent, may be beneficial in refinancing, Henn says.
While you'd like to find a loan with low closing costs, you need to examine the whole deal.
"The cheapest closing cost, let's say $200, may not be the cheapest overall if the new interest rate is 1/4 percent higher than what another bank is offering," Henn says.
To do the math on your particular deal, there are some great online calculators to help. Try the refinance calculators offered by BankRate.com and CNN/Money.
2. Try a Shorter-Term Loan
Many homeowners, when considering a refinance, think about taking a shorter-term loan, such as a 20-year or 15-year mortgage instead of the traditional 30-year loan.
"The sooner the mortgage is paid off, the sooner you can work even harder toward your other goals, like planning for retirement," O'Meara says.
While it's tempting to pay off your house faster so you can be mortgage-free when you retire, it's not always the smartest move, because the interest rate differences, compared to a 30-year loan, may not be substantial.
"You may find that the interest rate only drops 1/4 percent when going from 30 to 20 years, but you may find a larger decrease when going from 20 to 15 years, such as a 1/2 percent drop," Henn says.
A shorter-term loan will mean a larger monthly payment -- something that can be a gamble in uncertain economic times.
Before you take the plunge, make sure your cash flow can handle a larger monthly payment. If you have any question about your job security, now may not be the right time, even if interest rates on shorter-term loans are lower.
Remember, if you go with a longer-term loan, you keep more flexibility with monthly payments. You can always pay more principal each month if you choose, but you can also back away if unexpected expenses occur in a month.
When I refinanced my home a few years ago, I had 23 years left on my 30-year mortgage. I gave serious consideration to a 20-year loan, because I didn't want to start from scratch with a 30-year commitment. In the end I decided to refinance to a new 30-year loan. My monthly payment was about $500 less than my old payment because of the lower interest rate. To shorten the term of the loan -- on my own terms -- I pay $500 more each month, the same that was due on the older mortgage.
If money gets tight, I like the security of knowing I can always pay less.
3. Vacation and Second Homes May Have Higher Costs
If you own a vacation home, the interest rate on your mortgage is probably higher than the one on your primary residence. That's typical in the business, because vacation mortgages are a greater risk to the lender. If a borrower gets into financial trouble, he's more likely to stop paying on a vacation home mortgage than the one for the home where he lives full time.
If you're thinking of refinancing your vacation home mortgage, the same rules apply. Run the numbers and see if they make sense.
Before you buy a second home, make sure you understand all the costs. In addition to the mortgage, you'll pay property taxes, insurance, maintenance, heating bills and more. You may also need to hire a management company if you don't plan to be there often, or if you plan to rent out the home when you're not there. (If you want to learn more about shopping for a second home -- perhps in a place you'd like to retire to someday -- read my previous column about how to audition the neighborhood before you buy.)
4. Proceed with Caution
If you're interested in refinancing to simply cut your monthly costs, great. But if you're thinking about pulling out some of your home's equity as part of the refi, tread carefully. While using your home's equity may seem like easy money if you're in a cash crunch, you have to remember it's not your own personal ATM. Consider these cautions before you make a move:
- To pay college tuition: Before you use home equity to pay college bills, learn about available college loans. Most have favorable interest rates and easy-to-live-with payment terms.
- For home improvements: Using your home's equity to pay for improvements can be a smart way to go, especially if the improvements raise the value of your home. "Sometimes I wonder if I should refinance back to a 30-year loan and take out a bunch of money to update this old battle axe of a house, which needs windows, two new bathrooms and siding," Falcone says. Don't overdo it, though. You probably won't recoup all the costs for improvements when you sell your home someday.
- To buy a vacation property: Vacation properties usually require a larger down payment to qualify for a mortgage, and using your primary home's equity for this may be tempting -- but it's not always a good idea. Pulling cash out of your home could increase the mortgage payment -- even with a lower rate -- at the same time that you're taking on the extra costs of a second home. Instead, think about banking the extra money you save because of your refinance, and you'll quickly build a healthy down payment for a vacation home.
- To pay off credit card debt: This is a dangerous area. While it's a great idea to pay high-interest debt with cheaper dollars, it's all about your spending habits. "If they are going to just run them up again, they are now in a more serious situation," Henn says. "If there is a pattern of overspending, then this may not be a good idea."
5. Shop Around
As with any financial product, shop around before you decide on a refinancing lender. Talk to your local mortgage banker, call the institution where you keep your checking account, and search online for lenders.
Check out sites such as LendingTree.com, Zillow.com and Quicken Loans to compare rates in your area.
Back in Massachusetts, the Falcones still are weighing their options. Lauren Falcone says she wants to keep shopping before deciding whether to refinance the family's home.