Daily there is news that mortgage rates are the lowest they have been in years. Everywhere there are promises of lower payments and low cost refinancing. But is it always wise to refinance into a lower rate? Is 2% lower rate still the rule of thumb? There are other considerations.
Calculate Mortgage Refinance Breakeven Point
Refinancing a mortgage isn't cheap and your credit will need to be reviewed by the lender. Costs will include appraisal, title search and insurance, points, lender fees, recording fees, etc. and if taxes and insurance will be paid through an escrow account, funds will be collected to fund that account (prepaids) as well. So, first of all, a homeowner needs to ask themselves if they'll be in the home long enough to recoup those costs. To determine the breakeven point, closing costs (not prepaids) is divided by the monthly savings amount. If plans are to stay in the home longer than the result of that calculation, refinancing may be a good idea.
What is the Refinanced Amount in Relation to the Home's Value? (LTV)
Everyone is painfully aware that in most areas of the country right now, homes have dropped in value. To add insult to injury, many of the mortgages on those homes were provided at a high LTV. Often, if a borrower's credit was strong enough, they obtained a mortgage for 100% of the purchase price (100% LTV).
In other cases, the borrower may have made a 20% down payment, and later obtained a home equity loan to finance a home improvement which gobbled up the equity position. And when a lender looks at a refinance of the primary mortgage they also consider any other liens on the home.
In either situation, since values have dropped, many borrowers are now upside down on their homes and no lender is willing to finance a home on a conventional mortgage above its value.** The one exception to this was on a VA mortgage wherein a borrower can take advantage of the VA's Interest Rate Reduction Refinance Loan which will refinance VA mortgages regardless of the LTV position.
What Is The True Savings of Refinancing a Mortgage to a Lower Rate?
If the home is one that the owner plans to stay in indefinitely, they should first take into account how much principal and interest is left to pay on the current loan vs. how much will be paid during the term of the new one. Is there really a savings?
Here's how to would calculate this:
Current Mortgage is a 30 year term, and they have made principal and interest payments of $1199 for 4 years. They now have a quote for 1% lower than the current rate on a new 30 year mortgage with a payment of $1074.
Months left on current mortgage x P&I amount of current payment = Total $ of repayment
- 312 months left x $1199 = $374,088
Term of new mortgage x Principal & Interest amount of new payment = Total $ of repayment
- 360 months x $1074 = $386,640
In this example, refinancing to a lower rate would cost an additional $12,552 at the end of the term. If closing costs were rolled into the loan that amount would be even higher! The only way to get around this is to refinance into a shorter term or make extra principal and interest payments on the new loan.
In summary, when considering a mortgage refinance, look at the details, do the math and obtain the advice of a trusted mortgage consultant.
Note: The recently enacted Homeowner Stability and Affordability Plan may provide a solution to homeowners who are outside the standard refinance parameters.
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