September 17, 2020
By Rahul Iyer
Interest rates are the lowest they’ve ever been, but does that mean you should refinance? Most people assume you should, but it doesn’t always make sense to do so. Refinancing can be great in the right circumstances, but it can also cost you a lot of money if you aren’t careful.
Before you refinance, consider the following.
Remember when you bought your home? You paid closing costs and you’ll pay them again if you refinance. Closing costs usually cost 3 – 5 percent of the loan amount. On a $200,000 loan, that’s $6,000 - $10,000.
Suddenly that low interest rate doesn’t seem as attractive. Here’s a quick way to tell if it’s worth it.
Total closing costs/Monthly savings = Break-even point
Your break-even point is when you’ll ‘pay back’ the closing costs and start reaping the monthly savings. For example, if closing costs are $3,000 and you save $150 a month on the new mortgage, your break-even point is 20 months or just short of two years.
If you’ll move within 2 years or shortly after that, you won’t make much on the deal, so it wouldn’t be worth it. If your break-even point is much more than a few years, it’s generally not worth it.
Getting caught up in the interest rate may make you forget the loan’s term. If you have a 30-year term, for example, but you already paid on it for 10 years, taking out another 30-year term to get the lower rate adds 10 years back on your loan. If you can’t refinance at a term that’s similar to the time you have left, it’s not worth it.
If you took out an adjustable rate loan or you have a 30-year term but can now afford a 15-year term, refinancing makes sense.
Refinancing out of an ARM eliminates the risk of increasing interest rates. You can’t predict what your rate will be year-to-year, which is scary. Locking in a low fixed interest rate now makes budgeting easier.
Refinancing into a shorter term loan could save you thousands of dollars in interest. With the low interest rates today, it’s a great time to jump into a lower term and pay your loan off faster. The long-term savings far outweigh the loan’s costs.
Look at the big picture before you refinance. How much will you save overall? Focusing only on the monthly savings can be deceiving. Your home is your largest investment. Step back and determine how it affects your overall finances.
The faster you can pay the loan off, the less it costs overall. Focus on that end goal and determine if refinancing will set you back or push you toward your goal. If you do refinance, look for the lender with the best rate and loan costs to make refinancing well worth it.