A while ago, my wife and I were looking to sell our house and upgrade to a larger home. Our family was outgrowing our starter home. We had made some pretty dumb decisions when we bought that home. We had no idea what we were doing. We didn’t shop around for the best mortgage, we simply used the mortgage broker recommended by the real estate agent.
Things were different when we bought our next (and current) home. I wrote about some of the things I learned the first time around in 4 Tips For Applying For a Mortgage.
Another dumb thing we did was refinancing about a year into owning the home. We had just had our 1st baby, and had a tough time making ends meet so when the broker called and said we could cut our monthly payment by “as much as $50!”, well we jumped on that deal.
Of course, that $50 set us back a year on paying off the loan, not to mention all the extra financing involved because we rolled the refinancing cost into the new loan.
That’s not to say that refinancing your home is a bad idea. It just depends on the circumstances. A year into the loan, with not much lowering of the rate (we shaved about 0.25% off our rate) doesn’t make much sense, unless it’s trading an ARM for a fixed.
Well, back when I was shopping around for the best mortgage rate I contacted lendingtree.com. I ended up using a local bank instead, but lending tree still sends me their newsletter from time to time.
This week’s newsletter had a link to their article 4 steps to evaluate your current mortgage loan.
I thought I’d share some thoughts on their list, but feel free to read the full article on your own.
Here’s the gist of their list of when it makes sense to refinance your mortgage.
- You have an adjustable-rate mortgage (ARM)
If you have an ARM, and the terms don’t specify a prepayment penalty then it may make sense to refinance to a fixed rate loan. The prepayment penalty may be costly if you refinance, since you are in essence making one, big prepayment on the entire loan itself.
- Your current mortgage rate is considerably higher than current mortgage rates.
I interpret “considerable” to be about a percentage point or more, also known as 100 basis points or more. I just don’t think it makes good sense to lengthen your loan (which refinancing does) to save less than a percentage point. You’re better off making an extra payment or more every year. You’ll save more interest AND own your home free-and-clear sooner.
- You expect to be living in your home for another 7 years or more.
The Lending Tree article mentions doing the math to make sure you stay in the house past the point at which you break even and make up the cost of the refinance, but there are other market conditions involved. If you stay to the break even point, and then decide to sell you may still lose out if the market hasn’t risen. 7 years may not be enough time for your home to appreciate, but it seems like a point at which the odds are in your favor.
Lastly, it doesn’t always make sense to refinance your mortgage. For example, I don’t think it makes sense to refinance my mortgage because the change in rate isn’t enough and I have my own plan to pay the mortgage off sooner anyway, which will save me more in interest payments over the long run.
Whether or not you will really save money by refinancing your mortgage is more than just using a mortgage calculator to see what your new monthly payment is. You need to think big picture too, as I laid out in my explanation of why I’m not refinance my mortgage.
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