Refinancing can save homeowners a lot of money, but not for long

If you’ve been debating whether or not to refinance your mortgage, you may want to make a decision soon. That’s because many say that mortgage interest rates are going to rise in the coming months, potentially even topping 5 percent.

Further, though rates have risen since last year, they are still historically low, and you should take advantage of that fact before normalcy – i.e., 5 percent and higher interest rates – reigns again.

“It is not normal for you to be able to borrow hundreds of thousands of dollars at 4 percent. That is not normal. And that can’t last,” says Bishoi S. Nageh, vice president of New Jersey’s Mortgage Network Solutions.

So we took a deeper look into some reasons you may want to consider refinancing before the end of the year.

Rates Are Going Up

At least that’s what a lot of experts think.

For instance, consider the projections by the Mortgage Bankers Association, which predicts that by the second quarter of 2015, the average interest rate on a 30-year, fixed-rate mortgage (FRM) will hit 5 percent.

Compare that to the 3.97 percent average interest rate on a 30-year FRM as of November 26, 2014, according to Freddie Mac, the nation’s largest mortgage holder.

And lest you think this is all just guesswork, guess again. There are some very solid reasons many experts think rates are going up. One is the strengthening American economy, says Nageh.

“If you look at earnings in companies in America, they’re doing very well. So, long-term, interest rates will go up, because there has to be inflation when companies are doing well. People are buying,” says Nageh.

What’s more, the Federal Reserve stopped their Quantitative Easing (QE) program in October, and as a result, we should be seeing higher rates soon.

In case you’re unfamiliar with this, the QE program kept mortgage interest rates artificially low by buying mortgage-backed securities. Without getting too detailed, this buying spree raised the price of bonds, which lowered mortgage interest rates.

With the economy doing better, there is no longer a need to keep rates artificially low, so expect rates to rise soon.

Small Amounts Become Big Amounts With Mortgages

You may say, “Why is 1 percent such a big deal?” Good question, because on the price of a sandwich, a sports coat, or even a sports car, 1 percent probably is not a deal-breaker.

But on a mortgage of hundreds of thousands of dollars, 1 or 2 percent can really add up.

Of course, says Nageh, if you bought your home in the last few years and have a great rate, refinancing probably won’t save you that much money, especially considering the costs and fees associated with refinancing. In fact, to make refinancing worth it, you’ll want to lower your interest rate by at least 1 percent.

“But when people are in a loan with a rate of 5 to 6 percent or more, and they want to go to 4 percent, refinancing usually makes sense,” he says.

The best way to see the numbers is to, well, see the numbers. So let’s crunch them to see the difference between three 30-year, fixed-rate mortgages for $300,000, but with different interest rates.

Interest Rate Monthly Payment Interest Paid Over Life of Loan
Mortgage A 6 percent $2,319 $347,515
Mortgage B 5 percent $2,131 $279,767
Mortgage C 4 percent $1,953 $215,609

 

Bottom Line: As you can see, the savings a few percentage points can make on a mortgage is slightly more motivating than on a sandwich.

Getting Out of an FHA Mortgage Can Save Big

There are many reasons that you may have an FHA (Federal Housing Association) mortgage, rather than a conventional mortgage.

For instance, says Nageh, if you have a bankruptcy or foreclosure in your past, these loans are more lenient when it comes to qualifying. Also, people can qualify for these mortgages with as little as 3.5 percent down.

But there is a downside, and it’s a major one: Private mortgage insurance (PMI). PMI is an insurance that most lenders will make you pay when you put less than 20 percent down on a home. But once you pay off enough of your mortgage to give you 20 percent equity in your home (based on the purchase price), you get to stop paying it. That is, if you have a conventional loan. If you have an FHA mortgage, you’ll have to continue paying PMI.

“FHA’s PMI is permanent. And even if you put 50 percent down, with an FHA loan, PMI is mandatory. And it can cost more than a few hundred dollars a month,” says Nageh.

So, if you have an FHA mortgage with a costly PMI, consider refinancing to a conventional loan.

“Even if people can’t lower their interest rate by much, or at all, they still sometimes refinance to get out of their FHA loan,” says Nageh.

Seeing the numbers, you can see why refinancing now could be a good call for a lot of people.

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