7 Common Myths about Refinancing Your Mortgage in 2019
A mortgage refinance can save you hundreds of thousands of dollars over the life of your loan. Even in periods of rising interest rates, the financial markets ebb and flow, creating lower rate refinancing opportunities — if you don’t get caught up in myths perpetuated over the years by friends, family members, the media and sometimes even financial professionals.
With the uptick in rates at the end of 2018, many people may have come to the conclusion that it’s not worth it to even explore a refinance. However, it’s always worthwhile to do your research. The following will provide some perspective to dispel myths about mortgage refinancing that may be harmful to your financial health.
Myth #1: The Federal Reserve is raising rates so refinancing doesn’t make sense
The Federal Reserve is the central bank of the U.S., and its goal is to promote a safe and stable financial system in for the country. The Fed has raised its benchmark interest rate nine times since 2015 as the economy continues to recover from the financial crisis a decade ago.
One of the most common and inaccurate myths perpetuated about mortgage refinancing is that Fed rate hikes immediately affect mortgage interest rates. The Fed rate hikes can impact borrowers, but they don’t always translate to higher mortgage rates.
With the media reporting day and night about pending and actual Fed fund rate hikes, it’s not hard to understand why many consumers would take refinancing off their financial radar. It’s hard enough to consider buying a home when mortgage rates rise, so it’s not surprising that fewer consumers are thinking about refinancing.
Often loan officers get panicked phone calls from current purchase customers seeing the news about the Fed raising rates by a quarter percent, demanding an immediate lock-in to their rate. They’re worried that their interest rate is about to rise in lockstep with a federal funds rate increase — but that’s simply not how mortgage interest rates work.
Mortgage rates rise and fall based on economic conditions both in the U.S. and internationally. And sometimes, as was the case from 2015 to 2016, mortgage rates actually drop, even when the Fed funds rate is increased.
Yes, Fed rate hikes to play a role — but it’s not as direct as you might expect. Mortgage rates tend to price in an expected rate hike weeks before it actually happens, so by the time the actual rate hike hits the newswires, it’s already been priced into the rates. Also, rates reported by the media are usually based on data that came out nearly a week before, which means if you’re looking through the newspaper on a Sunday morning, you may be looking at rates that are no longer available, or are actually higher than what is available.
The Freddie Mac primary mortgage market survey is one of the most quoted sources for current mortgage rates, and the survey is based on data collected from Monday to Wednesday, and then reported Thursdays. A lot can happen in financial markets in a couple of days, and the rates the media reports over the weekend may already be out of date based on market events occurring between Thursday morning and the close close of market Friday.
The bottom line: if you want to know what current rates are, your best bet is to try a rate comparison tool or pick up the phone and start calling some mortgage lenders.
Myth #2: You shouldn’t add years on to your mortgage by refinancing
While this may be true if you’ve had your mortgage for a long time, the myth falls short when it comes to refinancing a loan taken out within the last couple of years. Let’s take a $200,000 mortgage with a 5% rate, and assume you took it out exactly a year ago.
The principal and interest you pay monthly on that loan is $1,073.64. Over the life of that loan, you’ll pay $186,511.58 in interest, and after the first year, you’ll have already paid $9,932.99 worth of interest.
Now let’s look at what happens to that long-term interest number if you refinance to a new $200,000 30-year loan with a 4.25% rate. The monthly payment drops to $983.88, and over the life of the loan, the total interest paid drops to $154,196.73.
If you add back the $9,932.99 you already spent in interest on your current loan, it costs you $164,129.72 in interest for the new loan versus $186,511.58 for the old loan — you end up saving $22,381.86 in interest over the life of the new 30-year fixed rate loan. That doesn’t include the monthly savings of $89.76 that you’ll enjoy — if you multiply that by the 360 months of savings you’ll enjoy, you end up adding another $32,313.60 of savings over the life of the loan.
That’s over $50,000 in savings between interest and monthly payments — well worth the extra year you’ll add to the loan by starting over the 30 year clock on the refinance.
Myth #3: You need to save at least 1% in rate or the refinance isn’t worthwhile
Looking at the example above, you only save $89.76 monthly by dropping your rate 0.75%. However, if you look at how that savings accumulates over time, combined with the interest savings, it paints a very different economic picture.
If someone handed you a check every month for $89.76, or every year for $1,077.12, or every three years for $3,231.36, would you take it? You could increase your 401(k) contributions, deposit the savings into a family vacation fund, or apply it to the principal of your new lower rate loan to pay it off faster.
The 1% rule also falls apart the higher your loan amount is, especially with the increase in conforming loan limits across the US to $484,350. For example, a $450,000 loan at a rate of 4.875% would come with a principal and interest payment of $2,381.44.
A drop of just five-eighths of a percent, to 4.25%, would result in a monthly payment of $2,213.73, for a savings of $167.71 per month. That’s not a huge monthly savings, but annualized it adds up to $2,012.52 of cash every year that can be contributed to something besides mortgage interest.
Myth #4: You should never use a refinance to consolidate other debt
There is some truth to this, but it is relative to your individual financial situation. If you’re considering a cash-out refinance to pay off credit card debt, more than likely it’s because the monthly payments are creating some financial distress.
If you are at a point where you’re struggling to make the minimum payments on high rate credit cards, a mortgage refinance could help. A $2,000 credit card balance with an 18% annual rate takes 370 months to pay off if you make the minimum 2% payment — that’s 10 months longer than a 30-year mortgage.
Carrying higher balances on revolving debt can cause your credit score to drop significantly. Because a mortgage is an installment debt, adding to the loan balance will not have the same negative impact that maxed out credit cards will, and could actually even improve your credit score if you pay the cards off, keeping balances to a minimum in the future.
Myth #5: I should trust my lender about whether a refinance is worth it
It’s important to understand that there are two ways that lenders make money in mortgage financing. One is from the commission they earn by making you the loan in the first place.
They also receive income in the form of the interest you pay every month, and the higher the interest rate, the more income they earn over time.
When you pay off a mortgage by refinancing, the investor who was making money on the interest you were paying loses a stream of income. It may not make financial sense for your current lender to offer you a refinance, but that doesn’t mean you shouldn’t shop around to see what other lenders are offering.
In addition, mortgage rate pricing can vary significantly between different types of lenders. You’ll want to contact a mortgage broker, a mortgage banker and an institutional bank to get an idea of who is more competitively priced for your refinance.
Myth #6: If I have to pay closing costs, it’s not worth it to refinance
There are almost always closing costs associated with a loan, even if you don’t pay them out of pocket. A lender that advertises a no-cost rate is generally increasing the interest rates they offer to cover that cost.
Even factoring in the closing costs, refinancing can save you a significant amount of money in the long run. Let’s go back to our earlier math problems. Say you refinance a $200,000 mortgage balance with a 5.25% interest rate down to a mortgage with a 4.5% rate, with closing costs of $2,500.
With the payment dropping from $1104.41 to $1013.37, you’ll save $91.04 per month. If you divide the $2,500 of closing costs by $91.04, you get 27.4 months. That means in just a little over two years, you’ve recouped the costs you spent on the refinance, and everything after that point is pure savings.
The numbers are even more significant if you look at the long term interest savings. You pay $197,586.67 in interest over the life of the higher interest rate loan verses $164,813.42 for the lower rate. That’s a savings of $32,773.25 over 30 years, and it only costs you $2,500 to realize those savings in this refinance example.
You should ask any loan officer you’re talking to for a cost-benefit analysis like the one we just calculated above. If they don’t provide it to you, you’ll want to try a different lender.
Myth #7: My adjustable rate isn’t adjusting yet, so I shouldn’t refinance it now
An adjustable rate mortgage provides an initial fixed rate period, then becomes adjustable for the remainder of the life of the loan.
Because an adjustable rate can rise substantially after the initial fixed rate period, it’s a good idea to compare the worst case scenario against where fixed rates are now. That can help you determine if refinancing will help to prevent a large, potentially unaffordable increase in your payment in the future.
First you need to know what type of ARM you have. With ARMs, the first number represents the fixed rate period, and the second number represents how often the rate can change after the fixed rate period is up.
A 5/1 ARM will have the same rate for the first 5 years, and then it can fluctuate every year up to a lifetime cap that is usually not higher than 5% or 6%. During the variable rate period, your payment will be tied to the index you chose, which can vary based on the financial markets, and the margin, which is a fixed number added to the index to give you your total rate on an adjustable rate mortgage.
You’ll need to review your ARM disclosures to verify your current rate, margin and maximum adjustments. An example of a competitive ARM is one with adjustments of a maximum of 2% for the initial adjustment, followed by a cap of 2% per year, up to a lifetime maximum of 5% — this would be called a 5/1 ARM with 2/2/5 adjustments.
The initial adjustment is the maximum your rate can adjust after your initial fixed rate period is over. For example, on a 5/1 adjustable rate mortgage, your rate would be subject to a change after your 60th payment.
On a 5/1 ARM with a 2/2/5 adjustment schedule, if your rate is 4% for the fixed rate period, then the highest your rate would be after that initial period would be 6% (4% start rate + the 2% initial adjustment).
This is the maximum your rate can go up above your start rate for the life of the loan. If you start off with an initial fixed rate of 4%, the rate can’t exceed 9% (4% start rate plus the 5% lifetime cap = 9%).
Preventing a big increase later by taking a smaller increase now
It’s unlikely that current 30-year fixed mortgage rates are lower than the initial adjustable rate you have right now, but they may have dropped low enough that the increase will be relatively small. Let’s take a look at the table below and assume your rate started at 4% for a 5/1 ARM with 2/2/5 adjustments for a $200,000 mortgage in October of last year, and current 30-year rates are at 4.5%.
|Monthly Payments on a $200,000 ARM Mortgage|
|Start rate at 4% for 5/1 ARM||2% maximum increase (6% rate)||Lifetime cap 5% increase (9% rate)||30-year fixed rate at 4.5%|
Refinancing to a 30-year rate now will increase your payment $58.54 per month, assuming you finance $200,000 again. Your worst case payment after your 60th payment will be $1,199.10, which is an increase of $244.27 per month in payment.
The big question to ask yourself: is the $58.54 per month increase in payment now worth it to avoid a potential $244.27 monthly increase in five years? Or worse yet, a payment increase of $654.42 if rates rise to the maximum lifetime cap?
If you have plans to stay in your home for a period longer than your rate will be fixed, it may make sense to refinance to a fixed rate now, and take a slightly higher payment, than wait and hope that the rates haven’t risen to a point where the payment becomes unaffordable.
When in doubt, shop around
With any debt, you always want to make sure you are paying as little interest as possible, which usually translates to the lowest monthly payments. You can check rates on a consistent basis without having to apply for a mortgage loan, or use mortgage calculators to determine a target rate where you would want to pursue a refinance.
Don’t rely on the advertised rates on the weekends though — it’s very possible that they may have changed for the worse, or the better. A little extra research using online mortgage rate comparison tools will help you make informed decisions, and avoid believing mortgage myths that could prevent you from benefiting from a refinance.