2020 continues to be the year of volatility in our financial markets. Consumers do not have to look very far to see an advertisement for a mortgage refinance or may have even received a call from their current lender regarding lower rates available in today’s market. Or even heard of friends who recently refinanced at the ‘lowest rate’ or that they were able to secure a mortgage refinance for ‘free’. Unfortunately for the consumer, mortgage lending is not simple, and all mortgages are not created equally. Is a mortgage refinance right for you?
Why consider a refinance of your mortgage?
Low-interest rate environments such as we are experiencing currently allows a borrower to refinance to achieve one or multiple goals: a lower rate (less interest expense), a lower monthly payment, a decrease or increase in term, cashing out equity in your property, or more commonly a combination of these benefits.
When does it make sense?
As a rule of thumb, refinancing a mortgage usually makes sense when rates have decreased 1% or more from your current rate and you plan to stay in your current home for greater than 18 months. Every financial situation is different, and the 1% rule can be very different depending on your situation.
Why a 1% or greater rate reduction?
Contrary to some advertisements or neighborhood rumor, refinances are not free. Costs vary widely depending on the type of refinancing and the institution lending the funds. Some lenders charge a percentage fee based on the amount borrowed, others charge a flat dollar amount for the loan.
For example, if you are seeking to refinance a $300,000 mortgage and the lender charges 1% (a very common charge) that translates to a $3,000 fee. Therefore, we recommend a 1% or greater reduction in rate, as it will take several years to breakeven and be money ahead.
Other lenders charge a flat dollar fee regardless of the amount borrowed, such as First Community Credit Union, which charges a flat fee of $695. This simplicity is a big reason that we recommend our clients explore their offerings. Check out their current rates here.
The varying costs of refinancing require that a prudent borrower receive the rate quoted as an annual percentage rate (APR). An APR factors in the lender or bank fees so rates can be compared apples to apples. We also recommend that the borrower explore offerings from at least three lenders to make sure they are receiving a competitive offering. It always helps to seek out help from a financial planner that can guide you to a decision that benefits your financial situation the most.
Example: Tye and Lucy are both 50, live in Bend Oregon, plan to retire at 65, and want to be debt-free at retirement. They have retirement assets and a taxable investment portfolio. How can a financial planner in combination with a refinance help their situation?
Tye and Lucy owe $200,000 on their home. Their mortgage is a 30-year term at 4.5%, they pay $1,520 per month and are halfway through the 30-year term. If they do nothing, they will be debt-free at age 65 and pay approximately $75,656 of interest over the next 15 years.
An alternative option would be to refinance the $200,000 mortgage to a more favorable loan. Say they could refinance the loan at 2.75% for 15 years, they would save $162 a month on their payment and $31,300 of interest expense over the next 15 years. The primary benefit is less interest expense.
But could we go further, saving interest and paying the debt down sooner? Using the same refinance terms above, what if we took $50,000 from their taxable investment account and only borrowed $150,000 for the refinance. They also will continue paying the same monthly amount as the original loan, $1,520. The results are substantial. They would save over $55,000 in interest expense and pay off the debt 5 years sooner than both situations above. Maybe they could retire early!
Everyone’s financial plan is different, and no two households will have the same solutions. It is imperative that financial decisions be made through a holistic viewpoint, taking all factors into consideration. Refinancing is just one facet of your finances and cash flow. Based in Bend Oregon, Ascent builds holistic financial plans that create clear roadmaps to your healthiest financial life. Reach out today for a free consultation with a financial planner.