Should You Refinance Your Mortgage? Rates Are Low, But It Is Still a Tough Decision

Record Low Mortgage Rates Make Refinancing Attractive

Mortgage rates continue to fall to almost unheard of levels. We’re talking about 30-year fixed rate mortgages hovering under 5%, and 15-year rates at just 4%. These rates are sharply lower than just a few years ago. But just how much can you save with a lower mortgage rate? Surprisingly, the savings can be quite substantial.

Let’s look at a $200,000 30-year fixed-rate mortgage. At 7% your monthly payment would be about $1,330 a month, less any PMI, escrow, etc. Now, take the same loan at 4.5% and the monthly payment drops to around $1,013. That’s more than $300 less each month. I don’t know about you, but I wouldn’t mind having an extra $300 in my pocket each month. And when you look at the total savings over the life of the loan, the 4.5% rate will save you over $95,000 in interest. It’s no wonder people are looking to buy a house or trying to refinance right now, but is it worth it?

Tighter Lending Limiting Loans

Even though rates are low, it’s more difficult to get a loan or to refinance today. Banks have changed their lending standards and it takes very good credit to get the best rates. A few years ago almost anyone could get a decent rate. If you bought a home with good, but not great credit a few years ago, you may actually find that the rate you can get today is not much better than your current rate. In some cases, you may be unable to get a loan or refinance at all.

There are also new fees being introduced to help lenders deal with risk. New risk-based pricing from Freddie Mac and Fannie Mae adds fees to mortgages based on a borrower’s credit score. In order to avoid the extra fees, borrowers need to have a FICO score of 740 or higher. While a score in the 700s is historically pretty good, you can now find yourself on the hook for added fees even with a 700-something score.

You Need Equity

Bad news for those of you in the more depressed housing markets. In order to refinance you usually need to have some equity in your home. A traditional refinance will allow you to refinance up to 80% of the home’s value. Well, if your $300,000 home you bought a few years ago is only worth $250,000 now and you still owe the bank $225,000 you very well may be out of luck. One exception is the Making Home Affordable plan, which can allow some refinancing on certain loans for certain people to be done without equity, but not everyone will qualify.

Thinking About Points

A lot of people think about paying mortgage points as a bad thing, but that isn’t always the case. The trend has been for lenders to require higher points for rates these days than a few years ago as they are looking for more money up front. Since points are essentially prepaid interest, this puts more money in the bank’s pocket early on. In some cases, paying points can result in a better deal, while some situations may end up costing the borrower money. Generally, the longer you plan on staying in the home, the more attractive it would be to pay points.

Julian Hebron, vice president and mortgage consultant at RPM Mortgage in San Francisco says  that paying points gets borrowers a bigger discount these days:

Historically, one point in fee gets borrower a rate that’s about 0.25% to 0.375% lower. Now one point gets the rate about 0.625% to 0.875% lower.

Recently, you could get a $417,000, 30-year fixed-rate mortgage at a rate of 5.625%, paying zero points. By paying one point (or $4,170) on the same loan, the rate went down to 4.875%, saving the borrower $261 per month in interest cost.

At this monthly savings rate, it takes 16 months to pay back the $4,170 and everything from that point forward is a benefit to you. Traditional breakeven periods are usually double this length of time.

Other Fees and Costs

Aside from paying points and possibly paying a higher rate because of your credit score, you still have all the other costs to contend with. It costs money to prepare a loan, and the underwriting and origination costs can easily be a few hundred dollars. You’ll also need an appraisal, which can again cost a few hundred dollars.

When you factor in all the costs associated with closing on a new mortgage or even a refinance, you can often expect to pay at least 3% of the loan amount in fees. This is especially important when you’re thinking about a refinance as the costs may outweigh the benefit of a lower rate in some cases. When you consider a $200,000 laon may end up costing $5,000  in total to refinance, what’s the breakeven point? If you’re saving $200/month by refinancing, it may take you nearly three years to make it worthwhile financially.

This is an important consideration if you’re unsure just how long you’re going to stay in the home. If the future is uncertain and you may be looking to move in a few years you could end up spending more to refinance than what you actually save. Also, remember that if you’re refinancing for the same loan term you’re resetting the clock. If you had ten years into your existing mortgage and then refinance into another 30-year loan you now have another 30 years before the loan is paid off instead of just 20.

A Lot of Things to Consider

As you can see, just because we keep hearing about how low the mortgage rates are these days, it isn’t always as easy as going to your bank and getting a new loan. With banks limiting these rates to those with the highest credit, regular people with average credit may not be able to find a loan or refinance for anything near what’s being discussed in the news.

In addition, if your future is uncertain and you may need to move in the next few years, the added points  and/or fees required to get the low rate or the fees associated with a refinance may actually cost you more money if you ended up not staying in the house as long as you expected.

So, if you’re considering the purchase of a new home or refinancing your existing mortgage, it’s certainly worth checking around to see what kind of rates you qualify for. But you want to make sure you’re actually going to save money and you’re not just jumping into a decision because the rates are at historically low levels. There are deals to be had out there, but it may be harder to qualify for them, and there may be other strings attached that make the lower rate not as attractive as it seems. Check to see what the latest refinance and mortgage rates are in your area.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

2 comments
torikul91
torikul91

I have already started reading some of your rates related article. i found great post here.I will get back here. I just added your blog to my bookmark sites. thanks. mortgage rates

Multiple Egg Baskets
Multiple Egg Baskets

The key is to find you break even point and to make sure that you properly account for all of the fees associated with a refinance. The Governement of Canada and a Royal Bank of Canada have two great calculators that help you to determine if you should break your mortgage.

Candee
Candee

It doesn't make any sense to refinance and pay points unless you get a really great discount. With many lenders, 1 point will still only buy down a loan by about 1/4 point. In addition, if your mortgage balance is already high, one of the biggest costs to refinancing is the loan origination fee, usually 1% of the loan amount. These two items are what drive up the cost of refinancing. Eliminate these and the cost isn't so high. Many large lending institutions (and don't overlook credit union) have eliminated the loan origination fee and are making it up by charging points. Look for a lender with the lowest fee structure even if the interest rate isn't quite as low and the highest buy-down rate for the least number of points. Of course, you have to meet all the other criteria as outlined in the post.