Refinancing mortgages has been a hot topic in the world of finance. Interest rates have reached record lows and mortgage companies are spreading the word about the benefits of capturing that lower interest rate. With the various headlines circulating the media, you may have begun to wonder if you should refinance now or wait until the rates will go even lower.
As a financial planning group, our clients have met us with the same question time and time again, “Should I refinance my mortgage?” As with any financial question our advisors get, the first answer is to look at how refinancing will affect the big picture of your whole financial plan.
There are obvious benefits of mortgage refinancing such as, paying off your home loan faster or lowering your mortgage payment. But there is a cost to refinancing. If the benefits of refinancing your home loan outweigh those costs, then it would make sense for you to go through with acquiring a new loan.
To understand how the mortgage industry works, let’s break mortgage refinancing down.
Refinancing is when a previous loan has been revised in terms of the interest rate, payment schedule, and terms. Borrowers mostly choose to refinance their mortgage when the interest rate environment has significantly changed, leading to potential saving opportunities.
When considering refinancing, there are several factors to consider. There are many steps of refinancing including, analyzing your current financial situation, calculating savings, choosing a lender, applying for a loan, and more. Do you want to refinance through your original mortgage lender or look elsewhere for a better rate?
If you can save money on your debt payments from a new agreement, how do banks make money? When you refinance, your lender pays off your old loan and gives you a new loan. There is a wide range of fees a borrower has to pay to refinance, including those that go straight to your lender. Those fees include:
Possible refinancing costs from your lender:
Other possible refinancing costs:
Even if some of the costs from the lender don’t immediately come out of your pocket, they can be factored into your mortgage total. For example, sometimes lenders will wrap appraisal fees into your mortgage.
Some lenders draw borrowers in by offering mortgages with no closing costs. This sounds like a good deal on the surface, but the lender must account for those expenses somewhere. In this case, the lender will often charge you a higher interest rate.
An appraisal is an important step in the refinancing process because the result of your home assessment will determine the value a bank is willing to lend to you for your home. The appraisal protects the bank by ensuring the borrower does not receive more money than the property is worth. If there are issues in your house you know will raise questions in the appraiser’s mind, you should have them fixed ahead of time. If your appraisal is unfavorable and your appeal is unsuccessful, your lender will likely require you to pay private mortgage insurance (PMI). Whether you are preparing for an appraisal or choosing solutions to make up for a low appraisal, these associated costs contribute to your total closing costs.
You might be wondering if you can lower the costs of refinancing by waiting for rates to go lower. This is a common misconception in finance. Waiting for interest rates to go down is like waiting for stock prices to decrease or waiting for that plane ticket price from New York to Australia to drop. Like the stock market, interest rates are unpredictable.
A good rule of thumb to determine your possible savings or losses is calculating the break-even point on a mortgage refinance. This can be computed by dividing the total loan costs by the monthly savings.
Let’s say the refinancing fees will total $5,000, while you will save $200 per month. Divide $5,000 by $200, which equals 25. The answer to this equation means you will recoup your costs in 25 months. Your break-even point is 2 years and 1 month. Of course, breaking even is not the real goal of refinancing. $0 is not worth all the effort that goes into it. When you reach the 26th month, the $200 would go into your pocket every month after for as long as you own the home. If you decided to sell the house after 3 years, you would save $2,200.
What amount of savings from a refinance will be worth it to you?
(Full disclosure: the break-even formula is not effective for certain refinance scenarios. If you change the length or term of your loan, savings could vary.)
It is crucial to understand the full terms of the agreement in order to calculate the total costs. Fees and savings are prudent to consider when deciding if refinancing makes sense for you. Additionally, the questions above can help you decide how those costs or benefits affect your personal financial situation.
If you are looking to save money, what do you plan to do with those extra funds?
Shortening the term of your mortgage loan can help you save money in the long run, but increasing your monthly payment can double the amount you have tied up in a financial commitment to your lender. If you aim to be financially free, to fund your child’s education, or have an ideal retirement, does paying extra on your mortgage help you save more for those goals? Instead of paying extra on your mortgage, you could grow your money by investing. Another option is using that extra cash to pay other high interest debt, such as credit cards or student loans.
On the other hand, your financial situation and future goals might allow you to recoup your money from refinancing. If those savings can help you reach your goals faster, why wouldn’t you refinance? Either way, it can’t hurt to investigate saving options.
If you remember anything from the initial home buying process, you know it can take time and effort to find the right lender, then dig through all the documents mortgage lenders require.
You may still be unsure of the ramifications refinancing your mortgage will bring. A financial planner can guide you through the steps, reduce your stress, and help you feel confident with your decisions throughout the whole refinancing process.
Spaugh Dameron Tenny is connected with many financial professionals. A good advisor builds relationships with other financial specialists to help you when you need their services. Much like a family medicine doctor or general dentist vets a surgery or dermatology specialist to refer patients to, advisors do the same with estate planning attorneys, tax accountants, student loan lenders, and of course, lenders. SDT advisors not only connects clients to a lender they trust but will also help you find the best interest rate and match your temperament to a specific lending professional’s.
Our clients often say they wish they would have started their financial plan sooner. So, what are you waiting for? We offer a complimentary discovery call to any doctor who has financial questions.
David Belinkie, CFP® is a Financial Planner with Spaugh Dameron Tenny, LLC. For David, the client relationship grows even deeper when the financial plan is put into action. He feels very strongly about educating clients so that they have all the information they need to make suitable decisions for their specific situation.
For over 50 years, Spaugh Dameron Tenny has provided comprehensive financial planning for physicians and dentists across the U.S. In addition to providing personalized advice, we walk our clients through their options to help maximize finances and maintain financial security.
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