Home Mortgage Refinancing: The Ground Rules
Home mortgage refinancing, a very open-ended and extremely subjective question as the answer lies in each and every homeowner’s particular situation.
There is no one size fits all solution and simply chasing lower interest rates by refinancing your mortgage every few years may not actually achieve your short-term or long-term goals.
Let’s, first of all, understand that the winners in this game of home ownership are the banks and lending institutions.
The tax deduction allowed is simply a tool used by the federal government to encourage home ownership to encourage more lending in this country.
We are a credit-driven economy. So let’s look at some general realities first.
On any mortgage note, most of the interest is always paid during the first part of the loan period. Basically around 18 years of the 30 years. After that more of your payment goes to the principal reduction rather than interest payment.
For a typical 30 year loan of $250,000 at 4% interest, you would have paid $176,965 plus the principle so you would have paid a total of about $426,965 plus tax, interest, and upkeep of your house over those thirty years.
When you add all of those in if the house was initially appraised at $300,000 you would have paid close to $574,882.
Now let’s say that 5 years into this mortgage you decide to refinance at 3% on a 15-year mortgage. Now you have already paid about $95,360 for living in this home for five years.
Given the same scenario above, just changing the interest rate to 3% and the term of 15 years, your total payments after 15 years are $382,845 plus the $95,360 that you previously paid you are now at $478,205 after 20 years. You saved about $100,000 and 10 years.
Of course, if you refinanced at the same 4% rate for fifteen years your total would be about $405,047 plus the $95,360 already paid so you are now at about $500,407 over 20 years.
The point here is that home mortgage refinancing may save you money but typically only if the interest rate is lower and the term is shorter. Check out Zillow.com for the current refinancing rates.
Let’s not even consider adjustable rate mortgages as an option. One never knows when the rate will adjust up, and in today’s low-interest rate environment, interest rates have nowhere to go but up.
The purpose of the above discussion is to simply show you the math involved. However, there are also other factors to consider before a home mortgage refinancing is considered:
- How long do you plan on keeping the house?
- What if a job opportunity requires relocation and you have to sell your house before you planned?
- Did the refinancing place your house upside down after a housing market downturn?
So with all of this in mind, let’s set some ground rules on home mortgage refinancing.
- Only refinance if you can get at least 2 percentage points better than your current interest rate.
- Would simply adding that extra payment or two per year to the principal put you in a better situation than refinancing
- Consider a shorter-term on the loan if refinancing
- Always make sure that you are at least 90% loan to value, 80% is better to avoid PMI. This is to buffer somewhat against a market downturn. Never take the lenders option to get 125% loan against the value of your house.
- Always consider your long-term goals of where you wish to live 10 years from now, do you truly wish to own the home or simply keep making mortgage payments for tax deduction reasons.
- Consider the fact that maybe after 30 years and you were to retire to a new location or even pass away, is it important that your heirs own the home? Most of the time, in our society the adult offspring do not even want the house they grew up in.
So this short report was to help you think through the issues of refinancing and not simply jump into another new mortgage because a loan originator told you that you qualify under new guidelines.