Don’t Refinance Until You Read
These 6 Simple Rules
We all want to be smart about refinancing our mortgage. Done right, it can save thousands of dollars in interest and lower your monthly mortgage payment. Done wrong, it can be a money loser if you have to sell. So don’t just pay attention to interest rates—follow these six refinancing rules to know when and how you should refinance.
There used to be a rule of thumb that said to refinance only when you could shave at least 1% off your interest rate. But with today’s ultralow interest rates, that rule has gone the way of the VCR. Today, the ability to shave your interest by half a percentage point is a viable option.
But don’t go chasing interest rates with refinancing—you shouldn’t refinance more than two or three times during your loan.
You can refinance your Federal Housing Administration loan into a different mortgage to shed any FHA premiums.
Many FHA loans require mortgage insurance for the life of the loan. For example, if you have a 30-year FHA loan and put less than 10% down—a common move for FHA borrowers—you would be expected to pay premiums for the life of the loan. Other nongovernment loans (except Veterans Affairs loans) may require private mortgage insurance, which can be canceled after you reach 20% equity in your home.
And although the FHA recently dropped rates, paying a monthly premium when you have decent equity built up isn’t desirable. Plus, the FHA could always increase its rates in the future. Just be sure to compare your new PMI rates with your old premiums to see how much you’ll save.
After five years of homeownership, refinancing one 30-year mortgage into another 30-year mortgage isn’t always the right move, even if you save money on a rate reduction. You can save money on a monthly basis, but you’re also resetting the mortgage clock and adding another five years to the life of your loan.
To reduce the pain, try to pay a little extra toward your new mortgage each month. Any extra money you pay will go toward your principal, which will build you equity faster and reduce the total amount paid on interest.
You should also consider shorter loan lengths if your financial situation has improved.
For example, say you have had a 30-year FRM of $350,000 at a 4.7% interest rate for five years. After five years of on-time payments, you owe $320,000 on your mortgage.
If you refinance that $320,000 into a 15-year FRM with an interest rate of 3%, you’ll pay $602 more per month—but after 15 years, you’ll own your home outright. You’ll also have saved $218,419 in interest payments.
It’s not the right situation for everyone, but crunch the numbers to see how much a shorter loan could save you in the long run.
Because refinancing comes with closing costs, you can determine when you’ll be able to recoup those costs with your monthly savings.
For example, say you spent $5,000 in closing costs to refinance and your new mortgage saves you $250 a month. It’ll take you 20 months before you recoup your closing costs and actually begin saving money. If you can recoup those costs in less than five years—preferably within three years—of a refinance, you’ve made a good deal.
This is especially important if you are considering selling. In the above example, if you sell within that 20-month time frame, it’s a money-losing proposition.
Don’t just go to your old lender for a refinancing package. It pays to shop around—don’t assume because rates are at all-time lows that they’ll be the same every place you look. Rates can differ substantially among lenders when there are lots of people shopping for a new mortgage.