Every time mortgage rates start falling home owners wonder if they should refinance their home mortgage. The biggest questions to answer are how long you plan to stay in your house and how much can you save each month after refinancing. By knowing your monthly savings you can figure out how quickly you can make the closing costs worth the closing expenses. With rates currently close to all time lows many home owners can make up the closing costs in less than a year and then every payment after that helps save money for the rest of the mortgage.
Some home owners like to refinance to lower their monthly expenses while others keep their monthly payments equal to their original mortgage payment and overpay each month. Overpaying like this reduces principle faster and allows the home owner to pay off their home loan sooner than originally planned. By scheduling a mortgage to be paid off by the time the owners retire they reduce fixed expenses at the same time income decreases.
Home owners should be careful in believing in the perceived benefit of writing off interest for tax purposes on a home mortgage versus not paying the interest in the first place (by paying off the mortgage, not defaulting). A home owner deducts interest from a home loan from income, not directly off of taxes owed. That means that for every dollar spent on interest only 20-30 cents is saved on taxes. That’s 70-80 cents wasted. On the other hand with rates as low as they are today you might be able to make more investing the money. This can be a valid point, but as volatile as investing in stocks can be, another form of diversification can be wise. Paying down a mortgage quicker can be worth the opportunity cost of a small portion of a family’s investment dollars. Overpaying by as little as $2-300 extra each month towards principal can save tens of thousands of dollars and take years off of a home mortgage loan.
A good mortgage broker should give multiple quotes with varying loan discount points. This is basically how much interest is pre-paid. For most people, there is no reason to pay interest in advance, but it can reduce the monthly total payment some and is worth considering if that is a goal. If not, use the extra money to pay down the principle further in advance and get a benefit from a lower beginning principal. Home owners with a loan less than 80% of the home value can avoid paying property mortgage insurance (PMI). PMI is for the benefit of the lender, not the borrower and should be avoided whenever possible.
Bankrate.com offers a free mortgage calculator to figure out the loan amortization schedule and offers options to see how overpaying can affect the amount of interest paid and the length of the loan. As an example, if someone originated a loan three years ago and was paying 4.875% on a $300,000 loan the monthly principle and interest payments would be $1,587.62 and the loan would be paid in full 27 years from now in October 2038. By refinancing the balance ($280,493.36) at today’s rate of 4.25%, the new payment would drop to $1,379.86 and the loan would be paid in full in October 1941. If the monthly savings of $207.76 was applied to the principal payment each month the payoff date would change to December 2034, nearly four years before the original loan was scheduled to be paid in full. That’s enough of a savings to deal with the short term headache created by the mountain of paperwork required these days.
AF Capital Management recommends speaking with Greg Spencer at Southern Capital Mortgage Group. Disclosure: Greg is an AF Capital Management client and I have used his services multiple times. This is not a paid advertisement.