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Should I refinance my mortgage? Here’s how to decide

Mortgage rates are around record lows. Is it time for you to refinance your home loan? The decision is not a simple slam dunk. Here are three questions to ask yourself first:

Refinancing
your mortgage costs money.

If you are planning to move in the next three years, the savings may be minimal. You may not live in your home long enough to cover the costs of getting the new loan. Instead, focus on getting in the best shape financially through paying bills on time, keeping other debt low and saving for the transition.

2. Where does your mortgage stand now?   

Beyond your current Interest rate, consider your principal balance, payment amount and the time left on your loan. If your principal balance is low, you may not gain from a lower interest rate because most of your monthly payment is going to paying down the principal, not toward interest.

Read your mortgage statement, which breaks down how your payment is distributed each month. You pay your greatest interest in the early years on a mortgage because your principal is largest. Each monthly payment is partially interest and partially principal. 

However, if your interest rate is significantly higher than what you’d get through refinancing — say 4% or 5 % — then a lower rate may save you money. 

Run the numbers, as I did for a client who had five years left on a mortgage. Despite the lowered rate, the monthly payments were going mostly toward principal so refinancing would not save money.

3. Do you have the money, time and credit history to refinance?

Closing costs are an integral part of mortgage process. They are due when you finalize or “close” your loan. These fees include mortgage application fee, appraisal, attorney’s fee, title insurance and other charges. Closing fees vary by state, loan type and mortgage lender, but the average cost of refinancing is around $5,000.  

Without the cash on hand, adding these costs to your mortgage means a large principal balance. This could eat into the savings from the lowered interest rate. Run the numbers: Bankrate.com, Zillow.com and Realtor.com (which, like MarketWatch, is owned by News Corp.) all have calculators.

Refinancing is time-consuming. At the very least, you need to share up to three years of taxes, a current pay stub and a net worth statement. A mortgage provider may request even more paperwork. 

You need a good credit score. This may not be the year for you to refinance, even with low rates. The past year has wreaked havoc on many people’s finances. If your debt is high versus your income or you have been late with payments due to the pandemic, you may not qualify for the great rates. Get your financial house in order and then apply for a new mortgage. 

This also applies to those who are unemployed because of COVID-19. Without steady income, your chances of getting a mortgage are slim to none. 

Ready to refinance?

If
after answering these three questions, you are ready to move forward, here are somethings
to keep in mind:

Principal balance matters

“Those
with a higher loan balance will break even sooner,” said Nick Parent, president
of Vermont Mortgage in Burlington, Vt. Simply because you have a greater
principal, the lowered interest rate has a greater impact.

Refinancing is about saving money on the interest you are paying to the financial institution.

This chart shows the interest paid over the life of a 30-year mortgage for $100,000 or $300,000:

$100,000

$300,000

3%

$51,777.45

$155,332.36

3.5%

$61,656.09

$184,968.26

4%

$71,869.51

$215,608.52

Home value matters

You must qualify for the loan based on a home appraisal. If you are in the middle of a home renovation, apply after you finish. That improvement may just gain you the equity you need to get rid of private mortgage insurance. PMI is a mortgage insurance premium if you do not have at least 20% equity in your home. The more equity in your home, the more you will save by not paying this monthly charge.

One caution is don’t get a 30-year mortgage because you have one now. If you have paid off five years already, don’t extend the term. Request a 25-year mortgage, even a 15-year one. The rates are lower with a shorter term. The rates of 10-year mortgages are right around 2%; a 30-year mortgage can be found for under 3%. 

One person I know refinanced and got a 20-year loan even though she was 15 years into her original mortgage. “I know I can make extra payments and be done in less than 15,” she declared. 

Yes, it
is nice to have flexibility but she would have paid less to the lender with a
lower interest rate and shorter term. 

Some
final words

“Shop around,” Parent says. Most people automatically go to their current servicer because it will be easy, he says. However, that rate may be as much as a half-percentage higher than if you compared rates, saving you more money over the long run.

He suggests you get quotes on the same day for the best rate and consistent comparison as rates fluctuate daily. Sure, check with your current mortgage provider; it may provide you some cost savings if it has a recent home appraisal, for example, but do not stop there. You can walk into a bank, use an online provider, or turn to a mortgage broker whose job it is to get you the best rate. 

Asking around doesn’t cost you anything but time, and it could save you money. The savings on a $100,000 25-year mortgage with an interest rate of 2.875% instead of 3% is $2,000 over the course of the loan.

Those choosing not to refinance still have ways to lower the overall interest paid and pay down the mortgage faster. Simple steps like making an extra mortgage payment a year and applying it to principal or paying your mortgage in two parts each month will land you ahead. 

Whatever you choose, remember to look at the long game and focus on getting your home paid off. 

CD Moriarty, CFP, is a columnist for MarketWatch and a personal-finance speaker, writer and coach. She blogs at MoneyPeace. Email your questions to MsMoneyPeaceQuestions@MoneyPeace.com

More from CD Moriarty: We still owe $46,000 on our mortgage — should we deplete savings to pay it off before we retire in 2021?

Also: Should I take a $1,913-a-month pension or a $445,000 lump sum?

And: Before pulling money from your retirement account, ask yourself these 5 tough questions

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