Don’t Fear the Refi: Serial Refinancing Can Help You Save Part 1
By Joseph Kelly
For the last three or four years, we have seen mortgage interest rates fall to the lowest levels in history. Homeowners are being constantly barraged with ads advising them to “Refinance Now”. It comes as no surprise that homeowners are becoming numb when they hear that mortgage rates have dropped, yet again. You may be one of those homeowners. The last time you refinanced you got a decent rate, so you assume it’s not worth the time or hassle to go through the mortgage application process again.
When you consider that your mortgage will always be your biggest debt, and the debt that will take you the longest to pay off, it’s worth a periodic look to see if refinancing again can save you money. After all, if you shave just ¼% off your interest rate, you’re likely to shave off 2-2.5 years off the life of your loan if you continue to pay the same amount you are currently paying.
According to CoreLogic, more than 70% of all outstanding mortgages have interest rates above 4 %. If your mortgage is one of these, you may benefit from refinancing, given that the average interest rate on a 30 year fixed loan, with closing costs, is currently 3.4%.
So here are three ways to make “serial refinancing” work for you:
Don’t let closing costs drain your equity: This is the biggest potential trap for serial refinancers. Paying closing costs isn’t always a bad idea. But before you do, you’ll need to run a “break even” analysis to figure out how long it will take before your monthly savings outweigh the cost you paid to get them. Depending on where you live, closing costs consisting of appraisal, recording fee, transfer tax, etc., total somewhere between 1 and 2% of the loan amount.
An easier way to understand this is to look at the difference between your current monthly principal and interest payment and the new monthly principal and interest payment, and then divide the closing costs by that number.
Example: Your current monthly payment is $700 and the new monthly payment will be $650 for a savings of $50/month. Your closing costs are $1000. 1000 / 50 = 20. It will take you 20 months (almost two years) to break even on closing costs. In other words, you’re not really saving money until month 21.
For the complete picture, you’ll also need to compare your tax savings between your current payment and your new payment, and include that in your break-even calculation. Ask your loan officer to run you those numbers if you’re not sure how to figure that.
Although many people fall for the pitch that they will pay “no money out of pocket”, in many cases the closing costs get wrapped into the loan. In those cases, you may not be paying the closing costs out of pocket, but you are paying out of your equity. There is another option, however, and that is a true no closing cost loan. The way it works is that on any given day, investors (such as Freddie Mac, Fannie Mae Wells Fargo, etc) offer a variety of interest rates for a variety of loans. Tables showing average mortgage rates, will list a range of interest rates for a 30-year fixed mortgages with different “costs”. (See an example of a rate table and the current week’s average national rates here.)
For example, on the date this article was written, an investor is offering a 3.5% 30-year fixed rate with 0 points to the borrower, or 3.375% paying 1 point. (Each point is 1% of the loan amount.) But going up the scale of rates, it’s possible to get money back from the investor. It’s called “premium.” So, for example, today an investor is also offering 3.75% with 1 point given back, which may be used as a credit towards closing costs.