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To Refinance, or Not to Refinance?

As interest rates have recently declined to now historic lows, the question of whether to embark on the home refinancing journey is now top of mind for many individuals. The current interest rate environment certainly provides opportunities that might result in savings or other planning advantages, but only after evaluating the entire picture. While we all wish it were as simple as seeing a lower mortgage interest rate and jumping on it, the analysis is not so straightforward.

As a start, you will need to meet some minimum standards to even qualify for a refinance:

  • History of regular, on-time payments on your original mortgage
  • Sufficient home equity (Equity under 20% might still be refinanceable, but likely at a higher rate)
  • Dependable source of income
    • This is especially important in the midst of this pandemic, as many lenders have tightened their qualification criteria. For instance, when I refinanced my home earlier this spring, I was required to provide additional paystubs beyond what is typically requested and a certification from my employer that my employment was expected to continue
  • Good credit

Then, you should consider all the costs associated with refinancing:

  • Closing costs: These typically range from 3-6% of the loan amount
  • Appraisal fee: You will likely be required to obtain a new appraisal on your home to qualify for the new loan. Streamline refinances are also available, which reduce the amount of paperwork and generally do not require an appraisal, but they also might result in a higher interest rate
  • Other miscellaneous fees: Application, credit report, recording, etc.

Finally, run a breakeven analysis of the data above considering the following factors:

  • How long do you plan on staying in your home?
    • It is important to consider whether you will be in your home long enough to benefit from any savings provided by a lower interest rate. Calculate at what point you breakeven on all associated refinancing costs and compare to how long you intend to remain in the house. If your lower monthly payments don’t offset your closing costs for 5 years but you plan on moving in 3, it may not be in your best interest to refinance.
  • How far along are you in your current loan?
    • If you are 10 years into a 30-year mortgage, refinancing to another 30-year mortgage and thus adding on 10 more years may result in higher cumulative interest over the life of the loan, even if the rate itself is significantly lower
    • Conversely, you might consider looking into a shorter term, such as a 15-year mortgage, but with caution. If you are not far along enough in your loan, bringing the mortgage term down significantly might result in higher monthly mortgage payments even with a lower rate.
    • If you are far enough along in your loan, it is possible you could end up paying roughly the same as your current monthly mortgage payment (or even less), but pay off your loan faster with a lower mortgage term.
      • For example, we have a client with 19 years left on their 30-year 4.38% fixed rate mortgage. The refi rate they qualified for on a 15-year loan resulted in roughly the exact same monthly mortgage payment, but they pay off their mortgage 4 years sooner, projecting to save over $30,000 in interest.

Also note that if you have an adjustable rate mortgage (ARM), interest rates are at record lows without much room to go lower, but plenty of room to go higher. If you have an ARM, depending on the length of time you anticipate remaining in your home, it may be beneficial for you to lock in a low interest rate now and not risk being subject to higher interest rates in the future.

It is easy to get excited about the astoundingly low mortgage rates. Refinancing has certainly made great sense for a lot of individuals. However, as always, it is important to make sure the true financial implications make sense for your unique situation.

Meghan Carson, CPA, CFP®
Financial Advisor


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