Mortgages

One Couple That Should Refi, And One That Shouldn’t

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Mortgage rates are at historic lows. So is now a good time to refinance your home loan? It depends. Let’s consider two different couples, one for whom it’s a good idea, and one for whom it may not be.

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First off, it used to be that refinancing was a good idea if you could lower your interest rate by at least 100 basis points (1%). This formula is no longer appropriate however, because in the current economy interest rates fluctuate continuously and property values also rise and fall without discrimination. For these reasons, the decision to refinance or not is best made in the context of your overall finances. For example, even if your current rate is not the most competitive, if you can make your loan payments every month and service all of your other debts without any problem, I suggest that you leave well enough alone, especially if your mortgage is close to being paid off.  I just don’t think it makes sense to get a new 15- or 30-year loan if you have just 10 years or less left on your existing mortgage. The reason is that if you refinance rather than paying off the loan you have now, you create a new debt with a new term and therefore, you end up making mortgage payments far longer than you originally planned.

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If your current mortgage won’t be paid off for many years however, and if it has an interest rate of 7% or more, then refinancing is something to consider — assuming you’ll be able to lower your rate to 5% or less.

To help illustrate, let’s look at two examples from my own practice. John, 35, is an electrical engineer and Mary, 33, is a human resources trainer. Together they earn $160,000 a year. They are in the 10th year of a 30-year, variable rate mortgage, which means that their loan interest rate changes every year based on the index their lender uses; however, the rate won’t go lower than 5% or higher than 9.5%. Right now they are paying 6%. Assuming that John and Mary can refinance into a fixed-rate, 15-year mortgage at 4.5%, they will shave off 1.5% for another 15 years and shorten the term of their loan by 5 years. Clearly, this scenario is a winner for the couple.

Refinancing is not such a good deal for Mike and his wife Janice, however. Mike is a 51 year-old commercial realtor and 50 year-old Janice is an administrative assistant for an attorney. They have a combined annual income of $110,000 and are in the 16th year of a 30-year, fixed-rate 5.5% mortgage. Although their bank tells the couple that they qualify for a 4.75%, 20-year, fixed-rate loan, if they pursue it although they will lower their interest rate by 0.75%, they will end up making mortgage payments for 20 more years rather than the 14 that are remaining on their current loan. Furthermore, their current interest rate is very good, even in today’s market. Looking at the math therefore, Mike and Janice are better off sticking with their current loan.

[Related Article: Underwater On Your Home Option 2: Refinance]

As you can see, there are no one-size-fits-all answers when it comes to mortgage refinancing. Whether or not refinancing makes sense for someone and the best terms of a refinance need to be considered on a case-by-case basis. Therefore, although opportunities to refinance have never been as attractive as they are today, it’s a good idea to consult with your financial advisor to make sure that making that move is in your best interest, and if it is, to ensure that the loan package you chose is the best one for you.

Image: Bill Ward’s Brickpile, via Flickr

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