Thinking of Refinancing Your Mortgage? A Checklist to Consider
Interest rates on fixed rate mortgages remain at historic low levels. The rate on the 30-year mortgage with no points is about 5 percent. But I don't think this situation will last much longer. Read my previous blog post for reasons why.
Homeowners with mortgages with balances up to the conforming limits and fixed rates above 6 percent (or an adjustable rate mortgage) who ignore this opportunity do so at their own financial risk. Here's a checklist to consider:
Run the numbers. The monthly savings from refinancing a larger mortgage are greater and can recover the costs of a refinancing transaction sooner than refinancing a mortgage with a smaller balance.
Consider refinancing if you have an adjustable rate mortgage. This is especially worth considering if your ARM is set to adjust before you plan to sell the house. You reduce your risk when refinancing to a fixed rate mortgage where the payment will be higher but never changes, versus continuing with an ARM that resets to a higher payment.
Consider a no-cash refinance. This may make sense if you don't have the cash to pay closing costs; you can roll the closing costs into the new mortgage. The result will be slightly larger mortgage amount, but smaller monthly payments. Then use the cash flow savings to make additional payments against the mortgage to quickly pay down the principal by the amount of your closing costs.
Calculate your break-even point to recover closing costs. Compare the monthly savings from lower payments to your closing costs to determine if you will recover your closing costs before you sell your home or otherwise pay off your mortgage. If you haven't yet recovered the costs of your last refinancing, you'll need to figure that in as well.
Look out for any prepayment penalty. Read your current mortgage note carefully to determine if any penalty applies for prepayments. Prepayment penalties typically apply in the first three years of your mortgage, and can be as much as six months interest on the original mortgage amount. On a $200,000 mortgage, that can be over $6,200.
Use escrow services. If you've been paying property taxes and homeowners insurance directly, consider using the lenders' escrow payment services. Often lenders will offer a lower interest rate if you agree to use their escrow services for payments for taxes and insurance.
Avoid state fees. Some states such as New York levy a mortgage tax of about three-quarters of a percentage point to refinanced mortgages. The way to avoid this is to assign the mortgage to the new lender and have them modify it to conform to the terms of the new mortgage.
Finally, if your ultimate goal is to save money over the life of the loan, consider a 15-year mortgage. Interest rates for 15-year fixed-rate mortgages are around three-quarters to one-half of a percentage point lower than rates for 30-year mortgages. Since the mortgage will be paid off over 15 years, the payments will be more, but the interest savings are worth it.
And if you like the savings of the 15-year mortgage but need the flexibility of the lower payments on the 30-year mortgage, you can accomplish almost the same results by making an additional payment or two each year on a 30-year mortgage. If you do this, you can pay off a 30-year mortgage in about 16 to 20 years. If cash flow gets tight, you can fall back to the required payments on the 30-year amortization, and make extra payments later when you can afford to do so again.
