With interest rates being incredibly low, I have been asked the question over and over the past several months about whether or not it is a good idea to refinance a home. Here are 5 questions I would consider before taking the plunge to refinance.
1) How long do I plan to live in the home? Since most people don’t live a home for 30 years, you generally don’t see mortgages taken out on a home actually complete their full 30 year (or 15 year) cycles. Since there are so many variations of mortgages today, (i.e.- ARM’s, 5/1, 15 year, 30 year), it is important to make a determination first on how long you think you will live in your current home.
2) What are the costs to refinance my home? There is no so thing as a free lunch. If you choose to refinance your home, there will be costs associated with making that transaction. You will have a decision to make about whether to pay those costs out of pocket, or you can elect to ‘roll’ those costs into the new loan that you take out. This will mean that you are essentially amortizing those costs over the life of the loan. It is important to be very clear up front what your actual costs are before you determine what you new loan amount will be from the refinance.
3) Will my interest rate change at all before the refinance is complete? Over the course of the four to six weeks it could take to process your refinance, rates could change significantly over that period of time. To remove any last minute surprises, you will want to make sure to ask if the rate can be altered at all before your close the loan. Lenders will usually have a “lock-in” feature which you absolutely will want to make sure you understand. You may also be able to get an option to float down your rate for a small fee if rates actually go down before your refinance is closes.
4) Will I have to pay points or private mortgage insurance? These are two separate items, but both worth mentioning. Some lenders may quote you a rate based upon you paying ‘points’. A point is described as 1% of the origination loan, and it is one way that lenders/mortgage brokers make their money. Since lenders often encourage you to roll the closing costs into your loan and focus you on your monthly payment, you may not notice these fees which can lead up to thousands of dollars. In addition, the lender may require private mortgage insurance which is another fee to protect the lender in case of your default on the loan.
5) What is my break even? Once you figure out your new monthly payment, calculate the difference between your old payment and your new payment. If you take the total closing cost number and divide it by your monthly savings, this will tell you how many months it will take to break even. This is the easiest ball park method to answer how long you need to be in the home for this to make sense. Last, I always ask the question of will you actually save the new found cash flow? Many people refinance their homes only to take that cash flow and begin spending it on other discretionary items. The key to refinancing is that you put the new found money to good use whether it is building up a cash reserve, saving for retirement, or banking for your kid’s college education.
They usually say what goes up must eventually come down. In this crazy world of interest rates, I think what has come down must eventually go up. Take a look at this closely in your personal finances while rates are low. It could be one of the smartest financial moves you ever make.
oXYGen Financial, Inc. co-CEO Ted Jenkin is one of the foremost knowledgeable professionals in giving financial advice to the X and Y Generation.
Ted Jenkin, CFP®, AAMS®, AWMA®, CRPC®, CMFC®, CRPS®
Co-CEO and Founder oXYGen Financial, Inc.
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