I have past clients reach out to me quite frequently, asking if it’s a good idea to re-finance. The scenario is generally similar to this: I helped them purchase their home within the last 1-3 years, interest rates are now lower and their lender is reaching back out to them to offer them a lower rate that can save them money through re-financing. While it’s great to get your monthly mortgage payment lowered, there are a few other important aspects of this decision to consider. So, when is re-financing a good idea?
1) If your ONLY goal is to lower your monthly mortgage payment to improve your monthly cash flows, then re-financing might be a good option.
2) If your current loan is an FHA loan and the MIP (Mortgage Insurance Premium) doesn’t drop off for several more years or even the life of the loan, re-financing to a Conventional Loan might be a good idea.
3) If your credit score has improved significantly and/or market rates have improved significantly since you purchased your home, and you can qualify for a rate that is at least a half point better than your current rate, then re-financing might be a good option for you.
However, re-financing has several consequences that you should consider:
1) “Calculate Your Break-Even”-- On most re-financed loans in an appreciating market, lenders find a way to roll your closing costs & escrow reserves into the loan. This means you are likely adding thousands of dollars to your principal balance, which you will end up having to pay off over the life of the loan or when you sell your home. So, you should calculate the breakeven benefit—how much money are you saving on your new monthly payment compared with how much money you add to the principal balance? Divide the former into the latter to figure out how many months it will take you to benefit enough from the lower monthly payments to break even. If it’s 3 years or more, it’s arguably not worth it…but only you can decide what you consider to be worthwhile!
2) “Pressing Reset”-- 30-year notes are heavily front-end-loaded with interest, so each year you progress on your loan term you pay down progressively more principal and in return create more equity for yourself. When you re-finance, you are starting the entire loan term all over again—for example, if you have 27 years left on your note when you re-finance, you would be starting all over again on a 30-year term—so understand that you are pressing the “reset” button on your loan.