You refinanced your mortgage a couple years ago when refinance rates were rock bottom…or so you thought. Since then refinance rates have fallen even lower and you’re thinking should I refinance again? There is a downside to serial refinancing that can wind up costing you a lot of money; however, in some situations it makes sense to refinance that mortgage again. Here are the pros and cons of refinancing to help you make an informed decision and avoid losing money.
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Serial Mortgage Refinancing Can Bite You
Refinance rates averaged 5.5 percent in 2009 at the height of the refinancing boom. Many people, including most financial analysts predicted we had reached the bottom and rates would correct higher to just above six percent.
Instead refinance rates continued to fall and set new records for historic lows. If you took advantage of refinance rates during the past few years you might be surprised to find that some programs have dipped below three percent.
When Is Refinancing a Bad Idea?
One of the problems with refinancing your mortgage aside from the fees you pay is that you reset the clock on your home loan’s amortization. If you’re ten years into a thirty year mortgage and you refinance with a 30-year mortgage, you’re right back where you started with your amortization schedule.
Another problem with resetting the clock on your home is that your payments are front-loaded with interest. In the early years of your amortization schedule the majority of your payment goes to pay interest. Over time this changes and you begin building more equity in your home, stuffing less of your cash in the lender’s pockets.
In a down market this lack of equity building could result in being underwater, meaning you owe the lender more than your home is worth.
You might think that getting low refinance rates is the most important aspect of refinancing. It’s true that refinance rates along with the term length you choose determines your payment amount; however, the test of how good of a deal you’re getting comes from the fees you pay.
The more you pay closing on your new home loan the less benefit you’re getting from today’s best refinance rates. If you’re still recouping your out-of-pocket expenses from the last time you refinanced two years ago it’s going to take you that much longer to break even on the new mortgage.
Paying too much for things like the loan origination fee or discount points means it’s going to take longer before you realize any benefit from refinancing.
Tax Consequences of Mortgage Refinancing
Politicians love to scare people to further their agendas. That’s what all the talk about the fiscal cliff is about including axing the mortgage interest tax deduction. Many homeowners paying six percent or more have enjoyed a large deduction from their tax returns every year.
What do you think refinancing at three percent is going to do to that deduction? That’s another downside of record low refinance rates. Millions of homeowners are going to find their mortgage interest tax deduction shrink dramatically as a result of refinancing.
This is happening despite fear of falling off the fiscal cliff. It’s actually more of a fiscal slope and not a cliff but where’s the fun in falling down a hill?
Should You Refinance Your Mortgage Again?
You can calculate how long it’s going to take to break even recouping your out-of-pocket expenses to decide if getting lower refinance rates makes sense. This calculation is really just an approximation because factors like term length affect your ability to recoup closing costs. If you choose a longer term length than what you have on your existing mortgage you’ll never break even thanks to the additional years you’re financing.
To approximate your break-even point, add up all of your closing costs and divide by the amount your payment is going down by refinancing. Suppose for example refinancing is going to cost you $5,000 and lower your payment by $200. Divide your closing costs of $5,000 by the $200 you’re saving to get 25 month recovery for breaking even. This is in addition to the time left recouping fess from your first refinance if you took out the mortgage within the last year or two.
Minimize The Downside With a Shorter Term Length
If you’re paying on a 30-year mortgage you can reduce the negative impact of refinancing by choosing a 15-year term-length. It’s true that your payment might not go down with a 15-year mortgage but you’ll offset this with much higher principal reduction. Considering that 15-year refinance rates are typically a half point lower than their 30-year counterparts it’s an easy choice for the fiscally conservative.
You can also maximize the benefit you’re getting from today’s best refinance rates by minimizing what you’re paying at closing. Many of the fees you find in section 800 of your Good Faith Estimate Can be negotiated to pay less or not at all.
The loan origination fee is one of the most commonly overpaid fees found on your Good Faith Estimate. One percent is considered standard; however, I’ve reviewed community based credit unions that charge as little as $400 for their origination fee.
Invest some time comparison shopping refinance rates and fees across identical programs from different lenders and you can save yourself thousands of dollars at closing.
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