In this time of interest rates that seem to be constantly decreasing, you may be asking yourself “Should I refinance my mortgage?”. It makes sense right? Let me lower my monthly payment and save, save, save! But does it really make the most sense for your situation? Let’s dive into refinancing and the numbers behind the decision.
What is a Refinancing?
In the most basic sense, refinancing is replacing your current loan with a new loan at different terms. You can shorten you loan length or increase it. Interest rates can go up or down and be fixed or variable rates. There are so many options, it can be hard to decipher whether refinancing is right for you.
How do I Begin?
Great question! It can seem like a daunting task to start the process of refinancing. There are many online loan marketplaces, such as credible.com, that can help you find what is available to you. Spend a few minutes and take a look and you may be surprised at what you find. You may find many loan options, but how do you know what is best for you? Let us try to find the answer.
Fixed Rate vs. Variable Rate
A fixed rate is just how it sounds. The interest rate will be the same for the entirety of the loan. It will never change, no matter what happens to interest rates. This could be good or bad, depending on the current status of interest rates. As of May of 2020, I believe interest rates are about as low as they will realistically go. There is probably no other way but up for them at this point so a low fixed rate is the way to go over the variable rate.
A variable rate will change after a set period of time which is different for each loan. If you have a 5/1 Adjustable Rate Mortgage, your rate will change after 5 years to the market rate and adjust each yeah thereafter. If rates go up in those 5 years, expect your mortgage rate to go up too. Mortgages were discussed more in-depth in the article “Understanding YOUR Debt“.
Should I Refinance – The Numbers
The moment you have all been waiting for! How do the numbers play out? Depending on how long you have owned your home, and the equity you have accumulated, it may be the right decision to refinance your mortgage and extend the life of your loan while lowering your interest rate. You could save hundreds of dollars a month. Let’s look at an example.
You have been paying your $350,000 mortgage for 10 years at an interest rate of 4.50%. This gives you a monthly payment of $1,773.40 that you are struggling to pay every month. You decide to look up refinancing options and shop around to find the best rate.
You find a lender who will refinance your mortgage at terms that work for you. 3.50% for 30 years with a refinancing charge of 5% of the current loan value. Since you have been paying your mortgage for 10 years already, the mortgage loan now has a balance of $280,313. Based on the 5% refinance charge above, a refinance fee totaling $14,016 will be included in the refinanced loan. The new loan total will be $294,329 with a monthly payment of $1,321.67 for the next 30 years. That’s a savings of over $450 a month or $5,400 over the course of a year! That could really make your budget a success!
Downsides of Refinancing
Of course, there are downsides to refinancing. After paying the loan for 10 years already, you are now starting the timeline over. What does that mean? You now have to pay the loan for 30 more years instead of the 20 you originally had left. If you stuck to the original terms of the loan, you would pay $638,423 in total throughout the life of the loan. By refinancing you pay $688,608, an increase of $50,185. Those numbers includes 10 years at a payment of $1,773.40 and 30 years at $1,321.67. So while you do end up saving monthly, you end up paying more over the life of the loans.
Why Bother?
So why bother with refinancing if you will end up paying more? The reason is simple – Cash Flow. If you need the cash now to meet your current obligations and perhaps could use the savings to pay down higher interest debt like credit cards, refinancing could be a no-brainer, especially in the low interest times we are in.
Just One Example
The example above is just that, an example. This is assuming that you pay the minimum balance each month and that you decreased your interest percentage by 1%. Your situation could be completely different than the scenario above.
You could lower your minimum monthly payment by refinancing, but keep paying the amount of the original mortgage, therefore increasing the speed of your debt payoff. If you took the $451.73 that you saved each month and put it back into the new refinanced mortgage, the loan would be paid off in a total of 348 payments and at a total cost of $615,780.73. That results in a savings of $22,642.76! That is some substantial savings and well worth doing!
Alternatively, you could take the extra money saved and pay off higher interest debt that has been accumulating. Once you get that paid off, you can then roll all payments into your mortgage and truly accelerate your debt freedom. The sky is the limit! Thanks to compounding, if you use the money saved wisely, you can transform you entire financial well-being!
There is no right or wrong answer on whether you should refinance. Depending on your situation, it could be the right move to kick-start your debt payoff journey but it may not make sense if your interest rate is already low or you don’t have much more to pay on your mortgage.
Debt Payoff Schedule
To help you with this decision, I have created a Debt Payoff Schedule that you can use to evaluate your different options. All you need to do is fill in the blue highlighted areas with your scenario and you will get the results you are looking for! You can download it below or by going to the Downloadable Template page of the blog. If you have any questions, please feel free to contact me!