If you are like me, you have received an assortment of advertising for refinancing over the past 12 months. My wife and I bought our home just over a year ago but have received on average 2-3 pieces of mail each week concerning our mortgage. How do you know when it’s the right opportunity to make a move on these offers?
When we closed on our home in February of 2020, the interest rates were roughly at 3.5% for a 30-year fixed or 3.2% for a 15-year fixed mortgage. The highest peak over the past year was in the low 4’s (APR) and a couple of month’s ago it bottomed out in the highs 2’s (APR). At the time that I’m writing this post, the rates are almost exactly where they were a year ago.
Cue the phone calls & letters. “Take advantage of historic low’s! Get extra cash from the equity in your home.” These lending companies are not paying hundreds of thousands of dollars in advertisement costs for the good of mankind alone. That’s not to say they are doing anything illegal, but they do stand to make a profit in some of these deals. Without someone to explain the details you may not realize refinancing is not ALWAYS in your best interest.
Here’s a quick and relatively easy way to understand if refinancing is right for you.
You should refinance your home when your break even point is around the 2-3 year mark (or less).
What’s the break even point you say? It’s when the money saved from your lowered interest rate covers the closing costs associated with the refinance. (The average closing cost for a refinance is $5,749) Here are two general rules to know when your break even point is within this guideline.
- When you save around 1% or more in interest (APR). i.e. Refinancing from a 4.75% rate to a 3.75% rate.
- AND when you plan to keep the home for approximately 3 (or more) years. The average mortgage is only on the books 5.6 years. That is due to moving & refinancing. Because it’s hard to predict what will happen 3 years from now, you want to minimize your risk of not breaking even on a refinance.
How it works: Say you refinance on a home that you owe $200,000. Imagine you went from 4.75% to 3.75%. (1% savings!) That means you are going to save $2,000 each year on interest. If your closing costs were around $6,000 it would take you about 3 years to reach the break even point. Good deal!
Now let’s imagine a similar scenario but you only saved 1/2 a percent on your APR. It would take you 6 years to recoup the closing costs. If you bought a new home 4 years after your refinanced (think relocation because of a new job) you actually lost $2,000 in the deal! No good. Think what you could do with $2,000.
Maybe you’re thinking, “What about moving from 30-year fixed to a 15-year fixed?” Won’t you stand to save thousands of dollars of interest? Yes! We only recommend a 15-year fixed mortgage when buying a home (unless you can buy with cash.😁) Here’s why a 15-year fixed is better:
- Pay off your house faster (Think no payments!)
- Save money on interest (Think tens of thousands of dollars!)
- Gain opportunity capital (Think investing the money you saved with extra time in the market… compounding interest is your friend!)
Moving from a 30 to 15 is a change in term (360 months to 180 months). The above break even guidelines would need to be true in this case as well. If you don’t stand to break even in 2-3 years with closing costs, the better thing for you to do is keep your current mortgage and pay extra on the principle like it was a 15-year fixed. You can use the mortgage calculator here to figure out how much extra you need to add to your principal payment to be mortgage-free in 15 years (or sooner)!
If you have more questions or want to personalize your refinance situation book a free 45 minute consultation here and I’ll be happy to coach you on all your mortgage needs!