10 Apr 2020 Should You Refinance Your Mortgage? Here’s Why Emily and I Did.
In today’s brief we’re taking a break from discussing the current state of the economy and the stock market, two things out of our control, to turn our attention to something we can control: the interest rate on our mortgage. This isn’t to diminish COVID-19 and the impact it’s having. We understand many are still nervous and uncertain about what the future holds and we are working hard to communicate with you as much as possible. Please know we are always available by phone or email to discuss your portfolio and financial plan.
Back in 2007, a 30-year fixed rate mortgage was going for around 6.5% and hadn’t moved a whole lot in the last six or seven years. Then came the Financial Crisis. As the Federal Reserve dropped interest rates to keep the economy from seizing, mortgage rates proceeded on their slow and steady march, which began way back in 1981, down, down, down. When they first dropped below 5% in April, 2009, it was hard to believe, and we all had to shake our heads when they dipped into the threes a little more than two years later. See the chart below to see how mortgage rates have dropped over the last four decades.
As 2018 came to a close, the sub-4% environment seemed to be over with. Average 30-year rates were close to 5% and as the Federal Reserve implied future rate increases the thinking was mortgage rates would continue to rise, too. That was wrong.
As you can see in the chart above, after briefly touching 5% in late 2018, rates started moving down once again to where they stand now, between 3.25-3.5%.
Which presents all of us with a great opportunity to refinance. Which is exactly what Emily and I have done. In case you’re thinking about it, I thought it might be helpful to share our numbers along with questions you should consider before making a final decision.
After Emily and I completed our renovations in 2016, we locked in a 30-year mortgage with a rate of 3.875%, borrowing $298,000. Here are the specifics of our old loan:
Our first month’s payment consisted of $962.29 of interest and just $439.02 against the principal. After nearly 4 years, we owe a little less than $279,000.
Our new loan will be at 3% and the amount financed will be $279,000 plus $3,000 in estimated closing costs, for a total of $282,000.
Here’s a breakdown of our closing costs:
- Loan origination fees: $1,125
- Title insurance: $449
- Attorney fees: $775
- Recording fee: $64
- Total closing costs: $2,413
(Two items of note: first, we did not require an appraisal, saving us $475 and second, since we did not need an appraisal, the extra closing costs they collected from us will be refunded.)
And here are the specifics of our new loan:
As you can see, our monthly payment has dropped by $212 per month and of our first month’s payment, $705.00 goes to interest and $483.92 goes to principal. Emily and I are cutting nearly a full percent off our loan and trimming more than $200 per month in interest expense.
Of course, reducing interest payments is a great reason to refinance, but shouldn’t be the only reason as there are other things to consider. Here are three questions that can help you determine if it’s in your best interest to refinance.
The first question is: how much will your rate decrease? The more the better, and if you’re only improving your rate by 0.5% it may not be worth it.
The second question you must answer is how long you plan to stay in the home. Due to closing costs, the re-setting of your term and depending on how you use the savings, it can take a while to break-even. If you refinance only to move three years later, you may have less equity than you otherwise would have.
If you feel you will be in the home long enough to make it worthwhile, the third question to answer is: what will you do with the savings? While the former two questions are important, this is the most crucial.
Emily and I (and our kids!) could think of a thousand different ways to spend the $212 we are saving each month. In fact, we could spend it without thinking about it. Left to be absorbed into our monthly spending, absorbed it would be, so we must be intentional about what we do with it.
We have three primary options with our monthly savings: create additional flexibility in our budget for things that are important to us, invest, or add the savings as an extra mortgage payment. (Of course, we could do a little of each, but for the sake of this exercise let’s assume it’s an all-or-none decision.)
Emily and I are comfortable with our budget and so are choosing to do the latter, even though the second option (investing) would grow our net worth faster. Why? Because we can probably earn more than 3% per year on our investments over the long-term. This is a prime example of how financial planning is both art and science; Emily and I get some psychological comfort from paying down our mortgage that exceeds what we’d get by investing.
So, how is our loan impacted by paying extra? Well, for starters, instead of a 30-year loan (or the 26 ½ we have left on our original mortgage) it becomes a 23 ½-year loan. Second, we save over $50,000 in interest costs over our original mortgage, and third, our break-even point is a short 23 months.
On the other hand, if we refinanced and just frittered away the extra cash flow, we would never break even and would have added three-and-a-half years to our mortgage. Yes, we would have saved around $19,000 in interest over the life of the loan, but that comes out to an average of $50/month, nothing too significant.
So, should you refinance? As you can see, it depends. Hopefully this little exercise helps you think through it and, as always, give us a call so we can help you make the wisest choice!