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Money Girl
152 MG What to Consider Before Doing a Refinance
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Hi everyone, and welcome back to Money Girl's Quick and Dirty Tips for a richer life. I'm your host, Laura Adams. This week I'll be answering a voicemail question about how to know if you should refinance your mortgage. Hi, Money Girl, I have a quick question about taking a home mortgage. If I were interested in getting a lower interest rate on my home by refinancing my mortgage, but I still plan on moving out of my home in about two or three years, does it actually make sense? What type of things would I want to actually consider before taking the plunge and refinancing? Anyways, thank you, and my name is Ben. Ben, I appreciate you calling in with your excellent question. It's a perfect time to talk about refinancing, because right now interest rates are low. An interest rate is simply the cost of money. Rates in the U.S. fluctuate according to the monetary policy of the Federal Reserve, which is our central bank. When interest rates are low, money's on sale. As strange as that sounds, banks should display a big banner on their front door or website that reads bargain basement prices on dollars or we sell money cheap, because that's exactly what happens when interest rates go down. Low rates are great for borrowers, but not so good for lenders. Back in podcast 150, I discussed how low interest rates put a squeeze on your savings, and I gave tips on where to find the highest rates. When you put your money in a savings account, money market deposit account or a CD, you're the lender. You don't earn much on the money you sock away in the bank when interest rates are low. However, when the tables are turned and you're the borrower, low rates are great. The Freddie Mac website shows historical data for interest rates on 30-year mortgages since 1971. I'll include a link to that information on the blog at moneygirl.quickanddirtytips.com. In October of 2009, the average for a fixed rate 30-year mortgage was 4.98%. A year earlier, the same loan was 6.2%, and 10 years earlier, it was 7.85%. If you already have a mortgage, you had to borrow money at the prevailing interest rate at the time you took out the loan. Other factors influence the rate you were offered to, such as your credit score and the amount of your down payment, but the going interest rate is always the most important factor for a mortgage. So, when interest rates drop, it's a good idea to investigate doing a refinance. Whenever rates drop at least 1 percentage point below the rate you have, take a hard look at refinancing. Before I answer Ben's question about what needs to be considered before jumping feet first into a refinance, let me make sure you understand what happens when you do one. Refinancing is when you apply for a new loan in order to pay off an existing loan balance. The new loan could be with your same institution or with a different lender. You basically swap out a higher interest loan for a lower interest one, which decreases the amount of interest you have to pay. That sounds easy enough, but of course, there's a cost to doing a refinance. It seems like it takes a village to close a loan, and everyone gets their cut. Fees go to the lender or mortgage broker, the property appraiser, the closing agent or attorney, the surveyor, the local government, and maybe more people depending on where you live. Each lender has different requirements for doing a refinance. Most will require that you have a certain percentage of equity in your property. Equity is the difference between what your home is worth and what you owe on it. For example, if your home is valued at $200,000 and you have $150,000 mortgage, you have $50,000 in equity, which is 25% of the value. Just because you qualify for a refinance doesn't necessarily mean that it's right for you. Refenancing a loan can be expensive. The total cost will depend on the lender as well as the location of the property, and could be as high as 3% to 5% of the outstanding loan balance. The trick is to understand what a refinance will cost and how long it'll take to break even on those costs. In other words, when do you move from being in the red to being in the black on the deal? September is a great month for planning. We start thinking about the rest of the year, whether it's back to school, big year-end work projects, holiday plans or travel. Planning ahead is crucial in life, especially when it comes to what happens when you're gone. Getting life insurance may sound daunting, but policy genius makes the process a breeze. With policy genius, you can find insurance policies that start at just $292 a year for a million dollars of coverage. Some options offer same-day approval and avoid unnecessary medical exams. 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The Wells Fargo Active Cash Credit Card, that's real life ready. In terms of supply, learn more at wellsfargo.com/activecash. It's one thing falling in love with a house, picturing yourself moving in and calling it home, and quite another navigating the world of price negotiating, mortgage lenders, and finding the budget that works best for you. An agent who's a realtor can make understanding that world easier. Realtors have the expertise, access to proprietary data, and tools to help you get from imagining living somewhere, to actually doing it. That's the kind of help we can provide. Because that's who we are. Realtors are members of the National Association of Realtors. If you pay for a refinance, but don't keep the home long enough to cover the costs, you'll lose money. But if you do keep the property beyond the financial break-even point, you'll feel like a genius because you'll save money in the long run. You may be able to roll closing costs for a refinance into the new loan, which means you would have nothing or little to pay out of pocket. But doing that increases the amount you have to borrow and may also increase the interest rate you have to pay for the life of the loan. For that reason, it's important to ask the lender for a side-by-side comparison of all the terms for each loan option so you can carefully evaluate them. So how do you figure the financial break-even point? It can be a little complicated, but don't worry. I'll give you a great online tool that'll make it a breeze. The break-even point depends on various factors, including the interest rates on the old and new loan, total closing costs, your income tax rate, how long you plan to own the property, and any loan prepayment penalties you may have to pay. Then my recommendation is to use the refinance break-even calculator at dinkytown.com to help determine if refinancing makes sense for your situation. That calculator can help you cut through the confusion of making an important financial decision such as doing a refinance. But remember that it's not perfect. For instance, it doesn't know if you'll take advantage of the home mortgage interest deduction, which would decrease your taxes and after tax interest rate, you really pay for a mortgage. For more information about how the home mortgage interest deduction works, be sure to refer back to Show 141. But using a refinance calculator will show you how long you'd need to keep the property to recapture all your upfront closing costs, which is usually what most people want to know. The goal of doing a refinance is generally to save money on monthly loan payments by getting a lower interest rate. However, there are other reasons to refinance. For instance, you might want to convert an adjustable rate loan into a fixed rate loan. That would lock in a low rate if you believe interest rates are going to rise. Or you might want to cash out equity that you've built up in a property to pay for something like a remodeling project or the cost of education for you or a child. Whatever your reason for doing a refinance, be sure to carefully weigh all the costs against the savings you expect to receive. If you're not already subscribed to the Money Girl Podcast in iTunes, try it out. Go to iTunes.com, download their fantastic free program, search for Money Girl in the iTunes Store, and hit the subscribe button. It's free, and make sure that you'll get each new episode as soon as it's released. You'll find all my contact information and links to connect with me on Facebook and Twitter in the Money Girl section at quickanddirtytips.com. I'm glad you're listening. Cha-ching! That's all for now. Courtesy of Money Girl. Your guide to our richer life. Buying a home is one of the biggest financial decisions you'll ever make. Before you tour home, the real estate professional you're working with may ask you to sign a buyer's agreement, which describes the services you'll receive, each party's role and responsibilities, and how your agent will be compensated, all of which you'll want to discuss with them up front. So work with an agent who's a real tour. Real tours are members of the National Association of Real Tours, with a duty to honestly represent you and put your interests above their own. Because that's who we are. Imagine earning a degree that prepares you with real skills for the real world. Capella University's programs teach skills relevant to your career so you can apply what you learn right away. Learn how Capella can make a difference in your life at Capella.edu. Thank you.