Why Waiting to Refinance Could Cost You Big
Refinancing your mortgage can save you thousands, even tens of thousands — if you time it correctly.
In low-interest rate environments, borrowers with higher rates can apply for a new mortgage that either allows them to pay off their homes faster or secure reduced monthly payments. Now that rates are increasing again, those who haven’t taken advantage of the more favorable market may want to act. That’s especially true of borrowers who have since improved their credit scores or resolved other risk factors since they first took out their mortgages.
“I think if people were holding off on refinancing in the past, knowing that rates may only go up for some time, it may be good to re-evaluate whether now is a time to at least do the analysis and see if it makes sense,” said Roger Ma, a CFP and licensed real estate agent in New York City.
Does it make sense to refinance your home loan?
LendingTree tracks changes in interest rates in its weekly Mortgage Rate Competition Index. A borrower who refinanced a $300,000 mortgage in mid-November could have saved $33,655 by shopping for the lowest rate. There’s more money at stake in 2018 than in 2017 — those who shopped for their best rate could save an average of $31,000 over the life of the loan, up from an average $26,000 in savings in 2017.
Refinancing can help you secure a more favorable interest rate so that you can lower your mortgage costs and improve your long-term cash flow. There are several scenarios in which refinancing may make sense for you, and it’s worth considering whether these apply to your circumstances and how refinancing can help you reach your goals.
Borrowers whose incomes have increased since they first took out a mortgage may opt to take out a new loan with a shorter repayment period. Perhaps you were recently promoted at work or your spouse returned to the workforce after staying home to care for young children. Now, you’re keen to pay down your mortgage faster using the extra income.
You might consider refinancing to a shorter-term loan — a 15-year instead of a 30-year, for instance — with a better interest rate than you initially received. A shorter repayment period and more favorable interest rate could save you tens of thousands of dollars, according to Byrke Sestok, CFP and president of Rightirement in White Plains, N.Y. But your monthly installments will increase significantly under a shorter-term loan, so switching from a 30-year to 15-year mortgage may not be in your best interest if your economic situation is unstable.
Improved credit score
If your credit score has jumped since you took out your mortgage, you may want to see if you can qualify for a better interest rate. “I think that if you were in the 600s and you get your credit score up above 750, it’s probably worth taking a look at if the math is there,” Sestok said. Even if you’re not in a position to take out a shorter-term mortgage, a lower interest rate could boost your monthly cash flow through lower payments.
“There are folks who maybe had really horrible credit scores because of the crash in 2007, 2008 and 2009 — maybe they had gotten into a home and they defaulted ― and they got a 6 or 8[%] interest rate because they were a really bad credit risk,” said Dennis Nolte, CFP and vice president at Seacoast Investment Services. “[If] their scores have gotten much better, they might be able to refinance at a much better rate, at 4 or 4.5%.”
Sestok noted that you don’t need to complete a formal application to find out whether you’re likely to qualify for a better rate. A mortgage specialist will be able to evaluate your prospects before you commit to a refinancing application, so you won’t waste time if there hasn’t been enough improvement to impact your borrowing abilities.
Stabilize a variable-rate loan
Borrowers who took out an adjustable-rate mortgage (ARM) and are worried about rising interest rates can refinance into a fixed-rate loan to keep their payments both manageable and predictable. Sestok explained that refinancing is “creating a brand new loan for yourself.” So if you decide an ARM is too volatile for your comfort or circumstances, you can take out a fixed-rate loan to pay off the original mortgage.
Switching to a fixed-rate loan might be attractive if you’ve taken out a variable rate home equity line of credit (HELOC) as well, Sestok said.
“Depending on where you are with your original mortgage, it may make sense to refinance the whole package to lower your payments and keep you on the same repayment timeline, if possible, or maybe extend it out but keep your cash flow under control,” he said.
“We don’t know how high interest rates are going to move over the next few years, but variable rates are certainly under some pressure right now.”
Marguerita Cheng, CFP and CEO of Blue Ocean Global Wealth in Gaithersburg, Md., agreed that consolidation can bring predictability to variable loans.
“If you owe $25,000 on a HELOC, and you’re getting a bonus and you’re getting a tax refund, before you know it, your HELOC may only be $15,000. It may not be worth your time to refinance,” Cheng said. “But if you’ve done a project, and you have $100,000 floating, you may want to evaluate to see if it does make sense to refinance because rates are going up, and every time the rate goes up, your payment will go up.”
If you took out a “nonconforming” or jumbo loan when you first purchased your home and have since paid the loan down, you may want to see if you can refinance to a better rate with a conforming loan. The current limit for most conforming loans is $484,350 — jumbo loans exceed that amount.
Borrowers who previously took out jumbo loans but have paid them down below that threshold might consider refinancing to a conforming loan product to save money on their repayment costs and rates.
But you’ll want to carefully compare available rates against what you’re paying on your jumbo loan. Interest rates on jumbo loans have in some cases been more favorable than on conforming mortgages in recent years, and you don’t want to refinance to a higher rate.
Securing peace of mind for retirement
Refinancing is a way for homeowners who plan to age in place to gain a sense of security before they retire, according to Nolte. “I have clients in their late 40s and early 50s, and their goal is, ‘I want to be in this home, and when I retire, I want this home fully paid,’” he said. “If you’re in a 30-year loan you took out five years ago, so you’re in a 25-year, it might make sense to refinance to a fixed 15-year just for peace of mind.”
“It might not make the best dollars and cents decision,” Nolte added, but it can help people be disciplined and achieve their goal of paying off their mortgages by retirement.
When refinancing doesn’t make sense
The interest rate environment isn’t the only factor to consider when evaluating the possibility of refinancing. Under the right circumstances, refinancing can save you considerable money. But it’s not always the right option.
Drop in credit score
If your credit score has weakened since you first took out your mortgage, you’re unlikely to secure a great rate, Sestok said. Refinancing could also be risky if your job security is uncertain or you expect a change in your family’s income. He offered the example of a couple who plans to start a family soon and has decided that one parent will stay home with the kids full time. The drop in income could make it difficult for them to make higher mortgage payments.
Another critical consideration is how long you plan to stay in this house — what Ma describes as your time horizon. When you refinance, you’ll have to pay closing costs on the new loan, and it will take several years before you’ll break even on those.
Ma offered the example of receiving a rate decrease from 4% to 3.5%. You’d be saving .5% per month, but you might also be paying $2,000 to $3,000 in closing costs. Unless you’re planning to be in the home at least three to four years, chances are you won’t break even.
Refinance versus home equity
If you need access to cash quickly — say, to put a new roof on your house or cover another big expense — a HELOC might be a better fit than refinancing, Nolte said. Although HELOCs are tied to interest rates and can be costly to repay when rates are rising, the math may work out if you expect to be able to pay off the loan within a few years.
HELOCs include appraisal and closing costs, but the latter is lower in these products than with a refinanced mortgage, Cheng said. She added that some lenders will waive closing fees for borrowers who commit to leaving their HELOCs open for a certain number of years. But she said that for borrowers who are uncomfortable with uncertainty, a home equity loan may provide both liquidity and predictability, while still avoiding the higher costs of refinancing. Repayment amounts on a fixed-rate loan remain the same each month, making it easier for borrowers to estimate their ongoing costs.
Cheng also noted retirees in particular need to think carefully before deciding to refinance. Someone who has been having health issues and thus may not be able to stay in their home long term, or who thinks their house is too much for them to maintain, may not be served by refinancing even if they can get a favorable interest rate. They may be better off with a reverse mortgage or another option, she said, depending on their needs and goals.
Make an informed decision
Both Sestok and Cheng recommended that borrowers who are considering refinancing speak with a professional before making a decision. While you don’t want to miss out on an opportunity to obtain a better rate or create stability ahead of further interest rate increases, you also don’t want to choose a path that will cost you more money in the end.
“Make sure you’re talking to somebody who can give you an overall view of your situation to see what [payment] structure makes sense,” Cheng said.
Sestok added that financial planners will often provide free initial consultations, so even a quick chat can provide some clarity. But it is worth looking into your options sooner rather than later so that you don’t miss a window of opportunity before rates rise again.
“If you think there’s an advantage in refinancing, you probably want to take a look now rather than wait because it’s going to cost you more later,” Sestok said. “Generally, if you think you can save a lot of money, it’s probably worth doing it.”