Everywhere you look today, people are jumping on the refinancing bandwagon. Interest rates are way down, though not as shockingly low as they were earlier in the coronavirus pandemic. With a refi, people are hoping to seize the moment and secure a lower payment, a shorter term, or both. Yes, there's quite a few reasons to jump on the bandwagon.
How high is homeowners' curiosity about refinancing? According to the Mortgage Bankers Association last month, refinance activity increased 89% in December 2020 compared to the same week a year before.
The appeal of a refi is plain to see. An interest rate only 1% lower than your current rate can nicely decrease your monthly payment. Even better, it means more of your money actually goes toward the house, building equity, and not into the bank's pocket as interest.
As you consider getting in on mortgage refinancing, learn what those who jumped on before you have to say. Recently we covered three topics at length regarding what surprised people when they refinanced:
- Our loan amount actually went up.
- We didn't expect our PMI to drop so much, and it's great!
- We wish we hadn't rolled other debt into the refi.
To continue the series, here are two more things people didn't know about refinancing until after they got into it.
"Shortening the Term Saved Us the Most Money"
A lower payment is what sparks many people's interest in refinancing their mortgage. Who wouldn't want to save a couple hundred dollars a month? Sometimes this savings is critical to a homeowner's overall budget, but sometimes it's not. Your current payment might fit into your budget just fine now, but you're looking to save serious money in the long-term.
Today's low interest rates present an opportunity to swap a longer loan term for a shorter one and keep your payment about the same. Shorter time means less time in debt and much less interest to pay.
Let's say you bought a home in 2014 and took out a mortgage for $300,000 at 4.5% fixed, a typical rate that year. Your payment is $1,520. As of today, seven years into the term, you have paid $89,743 in interest and still owe $260,538 on the home. Come the day you make your last payment and own the home in full, you will have paid $247,220 in total interest.
|
Scenario 1. Original mortgage, 2014 |
|
|---|---|
| Loan amount | $300,000 |
| Rate | 4.5% |
| Payment | $1,520 |
| Loan period in years | 30 |
| Balance after 7 yrs | $260,538 |
| Interest paid after 7 yrs | $89,743 |
| Total interest over 30 yrs | $247,220 |
In this scenario, what happens if you secure one of today's much lower rates but you keep making the same comfortable payment each month? You could shorten the loan term without breaking a sweat. Instead of lowering your payment by keeping the loan term 23 years (or worse, by resetting the clock back to 30 years), you hold the payment amount steady and see how many years you can lop off your debt.
Let's say you pay off the old mortgage by taking out a new one for $261,000 at 2.6% fixed. Making basically the same payment ($1,514) as before, you can own the home in just 18 years compared to 23. That puts you five years closer to living mortgage-free. Come the day you make the last payment, you will have paid $66,098 in total interest on this loan plus the $89,743 you paid on the previous loan, adding up to $155,841. That saves you $91,379 in total interest compared to not refinancing.
|
Scenario 2. Refi but keep payment same |
|
|---|---|
| Loan amount | $261,000 |
| Rate | 2.6% |
| Payment | $1,514 |
| Loan period in years | 18 |
| Interest over 18 yrs | $66,098 |
| + Interest paid on original loan | $89,743 |
| Total interest paid, both loans | $155,841 |
It's a definite win-win when you can cut five years off your mortgage period and save $91K in overall interest, all without changing your payment.
Either way, there will be closing costs.
Whichever way you approach a refi, know that there will be closing costs. It costs money to save money. Since closing costs vary widely by lender and locale, they were not included in the tables above.
So in the refi game, a lower payment isn't the only prize. Thousands of dollars in interest can be saved by lopping years off the term of the loan too. Ask the new lender to amortize your new loan over X-number of years so that your payment stays about the same as with the old mortgage but years vanish from the term along with many thousands of dollars in total interest.
“Between 1994 and the first quarter of 2020, the median number of years a borrower has kept a mortgage before refinancing is 3.6 years, according to data from Freddie Mac.”
"Selling the Home Was Harder Because We'd Rolled Other Debt Into the Refi"
As we discussed in our previous article about what people wish they had known about refinancing, rolling other debt into a refinance is rarely a good idea, mainly because it converts unsecured debt (credit cards, auto loans, student loans) into secured debt. Another reason it could be a bad idea is it might make your house harder to sell.
"When you sell your home, you have to pay off the mortgage in full," notes Money Crashers, "and you must also pay a real estate commission of approximately 6% on the sales price."
Let's say you used to owe $275,000 on a mortgage, and you refinanced to take advantage of today's much lower rates. Your new payment is wonderfully lower, yes, but with other debts rolled into the new mortgage (plus closing costs if you rolled those in), your new mortgage has a balance of $310,000.
Now you'd like to sell the home, and you need offers greater than $310,000 so that you can pay off your mortgage. But buyers will offer you what they think the house is worth, not extra to cover your previous debts.
"When you refinance and make your mortgage larger, you create a situation in which it’s difficult to entertain offers below your current mortgage amount. This is why banks typically won’t let you refinance a home unless you can keep your total mortgage amount below 80% of the value of the home," says Money Crashers.
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