By John Rapasky
You may have received a phone call, mailer, or email with the promise of low rates and lower payments. But, is simply reducing your payment the smart thing to do? Below are some thoughts to consider before you refinance.
The most basic analysis is to compare the savings to the costs. For example, if the costs are $2,500 and the savings is $100 per month, then it would take 25 months ($2,500/$100) to recover the costs. So, if you continue to live in the home for more than 25 months, you will benefit from the refinance. If you are going to live in the house for less than 25 months, then it would not benefit you to refinance.
Another level of analysis, that most do not consider, is the long term consequences of a refinance. Every time you obtain a loan, the lender informs you of the amount of interest you will pay over the life of the loan. For example, if you obtained a $400,000 mortgage at 4%, you would pay back $400,000 over 30 years, and $287,478.42 in interest. Therefore, to borrow $400,000, it will cost you $687,478.42. When you refinance, you should consider decreasing the amount of interest that would need to be paid over the life of the loan.
The more years you are into your mortgage, the less interest that is left to be paid. Even though you may be able to get a lower rate, and lower payment, you may have to pay more interest over the life of the new loan than what is remaining in the existing loan. If this is the case, then you may not want to refinance.
For example, assume you are 2 years into the above 30-year fixed $400,000 mortgage at 4%, and are paying $1,909.66 per month in principal and interest. The remaining principal balance on the loan after 2 years is $385,624.74, and the amount of interest left to be paid on the loan is $265,022.14. Assume you are offered 3.5% on a refinance. Rolling in closing costs and prepaid expenses for insurance and real estate taxes results in a new loan amount of $390,000. At 3.5% interest, the monthly principal and interest payment is $1,751.27, resulting in a monthly savings of $158.39, and total amount of interest to be paid on the loan of $240,459.87. In this case, it appears a refinance is warranted as you are reducing your monthly payment and the amount of interest to be paid on the loan.
Now, let’s assume you are 10 years into the $400,000 30-year fixed mortgage at 4% and you are offered the same 3.5% rate. The remaining principal balance is $315,136.02, and the remaining interest to be paid on the loan is $157,498.27. Assuming a new loan amount of $320,000 which includes closing costs and prepaid expenses, at 3.5% the new monthly payment is $1,436.94, which results in a savings of $472.72 per month. However, the amount of interest due over the next 30 years is $197,300.17, which is approx. $40,000 more in interest than the current loan. Even though you may be saving $472.72 per month, you are paying an additional $40,000 out-of-pocket over the life of the loan. Therefore, even though the monthly payment and interest rate is lower, you may not want to refinance in this case.
The decision on whether to refinance should be determined on a case-by-case basis. A lower interest rate and payment may not be enough to justify a refinance. Contact us and we can guide you through the refinance process and help determine if it is right for you.
John Rapasky is the President of the Counsel Mortgage Group, LLC. Copyright © 2016 Counsel Mortgage Group, LLC All rights reserved. NMLS #178927 NMLS LO# 179539 AZ MB #0909580 AZ LO #0911590 CA DBO# 60DBO43873 CA MLO# CA-DBO179539