At one point, I was addicted to the idea of home refinancing.
Internet popups would taunt me with historically low rates. And they were in the 3% range.
I kept watching the rates at our local bank, waiting to pull the refinance trigger. I wasn't happy with a rate over 5%, but I wasn't sure I wanted to pay the fees.
When we got our home, we paid three points to reduce the rate by 0.75%. We calculated it would take us four years to make the money back, and we'd save thousands over the course of the remaining payment years.
Points are fees you pay either to purchase or discount your mortgage. Each point represents 1% of the total amount financed. For instance, if you have a $160,000 home loan, one point costs $1,600.
Our bank offered to drop our rate by over 0.5% for just one point, but we decided we needed the money for home repairs.
Interest rates are still low, from a historical perspective. And since rates have been so low, countless Americans have considered refinancing as well. And while my refinancing involved my primary residence, others may be looking to refinance their rental property or other types of investment property.
Whatever your situation, there are rules of the road that you need to follow. Otherwise, your dreams of getting big savings from refinancing can turn into a nightmare.
Here are the questions you need to consider before refinancing:
How Long Will It Take For The Refinancing To Pay For Itself?
Refinancing can cost hundreds to thousands, but you just need a basic formula.
Divide the cost the bank quoted you for refinancing by the difference in your mortgage payment.
This will tell you the number of months it will take to pay off any fees. For instance, if you paid $1,200 to refinance your loan, and the difference in your mortgage payment is $50, it would take 24 months to pay off the refinancing fee.
Do You Have Savings For Home Repairs?
Especially if you don't have a home warranty plan, you need money available if the air conditioner breaks or the fence falls apart.
It's a good idea to have 10% of the price of your home in savings just in case you lose your job, need mortgage money or get stuck paying for major repairs. You might think you just need enough for one repair, but what if a tree bursts your pipes just after your air conditioner breaks? Each repair or replacement could cost thousands.
Do You Have Other Uses For The Money?
If you take the money out of your 401(k), you could suffer tax penalties for the retirement account withdrawal. If you have credit card debt, you could have used the money to pay off a credit card with a 20% rate.
In contrast, if you're earning a consistent rate of 5% on investments, it may not pay to take money out if your mortgage is less than 5%. You're earning more than you're paying on the debt.
Will Your Mortgage Start Over?
This often depends on whether you're offered a refinancing deal or a loan modification. A loan modification changes the rate for the rest of the loan, but refinancing starts the mortgage over.
For instance, let's say you have 22 years of payments left on a 30-year mortgage. If you refinance into a new 30-year mortgage, you'll be looking at eight additional years of payments. While the payment is likely smaller, you're still in debt longer. If you refinance a couple of more times, you could end up still having a mortgage when you're 90!
There is another option, however. If you're able to take your current 30-year mortgage (with 22 years of payments remaining, as I said previously) and refinance to a 15-year mortgage, you've saved seven years of payments. Then you just have to consider whether you can afford the payments.
The Investing Answer: Once you've carefully weighed whether refinancing is a good decision for you, get several estimates. You may be told by banks that rates can change tomorrow. While you shouldn't wait too long to make a final decision, take your time. You're going to be stuck with these payments for up to 30 years.
