Amidst the financial turmoil wrought by the pandemic, a notable silver lining emerges: mortgage interest rates have plunged to historic lows, dipping below 3% nationwide. Such rates for a 30-year mortgage haven’t been seen in nearly half a century. This enticing proposition is prompting many to consider borrowing at these remarkably low rates, with some homeowners contemplating refinancing their existing mortgages to capitalize on potential savings. However, whether refinancing proves financially advantageous in the long term hinges on various factors.
Look At Your Existing Mortgage First
Each mortgage is unique, with varying rates, terms, and associated closing costs, including potential penalties for early repayment. When contemplating refinancing, it’s essential to weigh these factors carefully. While plummeting interest rates may seem enticing, it’s crucial to assess whether the potential benefits outweigh the costs. Refinancing shouldn’t be undertaken solely based on external recommendations; individual circumstances play a significant role. Factors such as existing interest rates, mortgage duration, and associated penalties for early repayment must all be considered. Ultimately, the decision to refinance hinges on a comprehensive evaluation of one’s financial situation.
Interest Rate
Determining the potential reduction in your mortgage interest rate is crucial. A minimal decrease, such as 0.25%, may not justify refinancing. However, if you can secure a reduction of 0.5% to 1% (or more), significant long-term savings on interest payments become feasible. Yet, it’s essential to consider this alongside associated costs. High closing fees or additional expenses related to the new mortgage could offset the benefits of a lower rate. Therefore, a comprehensive assessment of all factors is necessary to make an informed decision.
Closing Costs
Closing costs are variable and can’t be entirely avoided. They generally range from 2% to 6% of the total mortgage value, meaning larger refinances incur higher costs compared to smaller ones. These expenses typically encompass application fees, home appraisals, and miscellaneous charges. Legal fees may also be included if legal assistance is needed. It’s crucial to receive a comprehensive breakdown of all closing costs associated with refinancing to assess the actual savings accurately. Sometimes, after factoring in these expenses, the purported savings from refinancing may diminish or disappear entirely.
Escrow
Whether this applies to you depends on your previous mortgage setup, as it’s common to allocate extra funds monthly for escrow, managed by your bank. This money covers annual property taxes and sometimes homeowners insurance. At the time of refinancing, the amount in your escrow account can vary widely. It’s crucial to be aware of this, as upon closing your old mortgage, the escrow funds are typically returned in a lump sum, potentially amounting to thousands of dollars. While this sum can be beneficial for covering expenses like closing costs, banks usually hold onto it for 30 or 60 days before releasing it to you.
Tax Considerations
However, it’s important to consider that property taxes remain due. With your new mortgage, you may be required to replenish the escrow account upfront, a common stipulation. The downside is that you may need the upfront funds before receiving the old escrow amount. This could lead to unexpectedly high closing costs. One strategy to mitigate this is refinancing for slightly more than needed. For instance, if you owe $150,000 on your existing mortgage, refinancing for $155,000 (at a lower interest rate with reasonable closing costs) allows you to use the extra $5,000 for closing expenses. Subsequently, upon receiving the old escrow amount, you can make a lump sum payment toward the new mortgage.
Length of Mortgage
Refinancing your mortgage can indeed yield savings, whether through reduced monthly payments or long-term interest charges, or possibly both. However, if you anticipate relocating within a few years, the benefits may be limited. The expenses associated with purchasing another home, including closing costs, legal fees, real estate commissions, and moving expenses, can offset any potential savings. Moreover, future interest rate fluctuations add uncertainty to the equation.
Conversely, if you intend to remain in your current residence for an extended period, or indefinitely, refinancing could result in significant savings over the life of the loan.
Should You Go Shorter?
Another alternative, if you have the financial capacity, is to refinance for a shorter term. Converting a 20-year mortgage into a 15-year one will lead to increased monthly payments. Nonetheless, the overall mortgage cost will decrease as you’ll pay less interest, and you’ll be mortgage-free five years earlier. If you’re able to manage the higher payments, consider investing in your future by opting for a shorter term when refinancing.
As mentioned earlier, the decision hinges on your specific financial situation and your monthly affordability. While refinancing with a shorter term will generate more long-term savings, you may find yourself with a tighter monthly budget due to the higher payments, despite the lower interest rate.
Your Own Credit
We understand the allure of record-low interest rates can be enticing. It might seem like everyone is benefiting and saving substantial amounts of money. However, one crucial factor that significantly influences mortgage applications is your creditworthiness. If you (and any co-applicants) have excellent credit and stable employment, then you’re in a favorable position. You’re likely to encounter fewer obstacles in the process.
However, if your credit is less than stellar or your job stability is uncertain—which unfortunately applies to many individuals currently—your options become less promising. You might find it challenging to qualify for those exceptionally low rates. In such cases, refinancing might not be financially beneficial, especially when considering other associated costs. This presents an opportune moment to assess your credit scores, rectify any errors in your credit history, or take measures to enhance your credit standing before pursuing a mortgage refinance.
Shop Around
Just like any other purchase, shopping around is essential when it comes to obtaining a mortgage (and let’s be honest, a mortgage is indeed a financial product you invest in). Don’t hesitate to request multiple quotes and carefully compare the offers. Each mortgage company will present slightly different terms, so it’s crucial to scrutinize them comprehensively. For instance, while some companies may advertise “no closing costs,” they might compensate by charging a higher interest rate, ultimately resulting in more interest payments throughout your mortgage term.
Moreover, certain lenders may be open to matching interest rates. If a lender offers you a rate of 2.5%, but a different bank proposes 2.25%, consider informing them of the competitive offer. Don’t shy away from negotiating for a lower rate or asking them to match the competitor’s offer. The worst they can do is decline your request.
Inflation
When contemplating refinancing your home, whether to achieve lower monthly mortgage payments or to save on long-term costs with a shorter mortgage term, it’s crucial to consider the broader impact on your budget. Any significant changes to your regular expenses, especially concerning such a substantial investment as your home, necessitate a comprehensive evaluation of your financial situation.
In this context, it’s essential to take inflation into account. Inflation results in the increased costs of everyday items and reduces the purchasing power of your income. Therefore, carefully weigh whether you’re prepared to increase your monthly mortgage expenses by opting for a shorter term, or if you’re comfortable extending your current obligations over a longer period and potentially paying more interest over time. Given that the costs of living will gradually rise, it’s imperative to adjust your budget accordingly.
The Future
The current state of the housing market can best be described as chaotic. Across major cities in North America, home prices and valuations are skyrocketing. While securing a lower interest rate on a property that has substantially appreciated in value since purchase may seem like a boon, it’s essential to consider potential downsides as well.
One significant risk is the possibility of a housing market crash. In such an event, those who refinanced their mortgages to extract equity could find themselves in a precarious situation where the value of their homes falls below their outstanding loan balances.
In Conclusion
Your mortgage represents one of the most significant financial commitments in your life and stands as your largest investment. Therefore, treating it with the utmost care is imperative. Dedicate considerable time and effort to meticulously analyzing the numbers, evaluating various offers, and seeking out the most advantageous refinancing option available. Despite the widespread financial concerns prompted by the events of 2020, there exists an opportunity to leverage the current circumstances to your advantage. However, exercising prudence and discernment is key to making informed decisions.