Barnett and Company

Another bite at the apple: Refinancing your mortgage

Following the Great Recession, mortgage rates plunged to historic lows in 2012. That presented a perfect opportunity to refinance and capture the savings. Many homeowners did, but some may have missed the boat.

Good news: the recent downtrend in rates has provided a second chance. And while the downtrend seems likely to continue for some time, it makes sense to start evaluating alternatives in order to profit from a new era of low rates. Let’s look at some options.

Suppose you took out a 30-year fixed-rate mortgage five years ago, leaving an additional 25 years on the loan. Assume the remaining balance today is $150,000, and your interest rate is 4.5%. Principal and interest payments are $834 per month (excluding any taxes, insurance or escrow payments). Over the remaining life on the loan, you will end up paying $100,000 in total interest.

What if you refinanced with a new loan at the current 3.8% average rate? Note first that those rates are available only to borrowers with good credit (generally a FICO score of 720 or better), and the comparison assumes a new 25-year loan. Many mortgage lenders today allow you to choose customized maturities. Try to avoid starting over with a new 30-year term.

Your monthly payment would fall to $775, saving you $17,000 in interest payments over the life of the loan. However, you must consider the closing costs and fees in order to evaluate the trade off. If the cost of refinancing is estimated to be $4,000, you will break even after about 5 1/2 years. Borrowers who plan to remain in the home for a longer period of time may find that worth the effort.

Now let’s look at a better option: shortening the term of the mortgage. The benefits are obvious but surprisingly rewarding, and today’s low rates make that a more affordable choice than in years past.

New 15-year fixed rate loans are available with rates as low as 3.3% (slightly better than 30-year rates). The new monthly payment rises to $1,058, an additional $224 per month. But the payoff is worth the sacrifice, saving you nearly $60,000 over the term. And you will be debt-free 10 years earlier.

There is also a hybrid option: create your own term by making additional principal payments or adding to the scheduled payment each month. That method requires discipline, but avoids the costs of closing a new loan and can be discontinued if financial circumstances change.

Adding an extra $50 to each monthly payment for your original loan raises the payment to $884. But since each overpayment goes directly to reducing the principal, you accrue a little less interest on the next installment. And even that modest contribution yields big results. You will save more than $11,000 in interest, and will pay off the loan 2 1/2 years earlier. Of course, you can increase the extra amount over time as you are able. And no paperwork: just write a bigger check.

A good first step would be to brush up on your credit score. There are now several options including some credit card companies, but everyone is eligible to see a copy of their file at each of the major credit bureaus once per year by visiting AnnualCredit

Then plug into one of many mortgage calculators to run various scenarios. MortgageCal, and are excellent tools to help you evaluate options.

A key consideration is the total cost of interest over the life of the loan. The recent rate decline has given many homeowners a second chance to save.

Christopher A. Hopkins, CFA
Vice President and portfolio manager
Barnett & Company

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