Yesterday I noted that we need to decide whether or not to refinance our mortgage, and I outlined our thought process. It’s not like we’re having any sort of mortgage problems, we really just want to ratchet down our rate. In short, we’ve been presented with an opportunity to do a no-cost refinance of our current mortgage balance from 6.375% to 6.125%. The total savings from this would be around $12.5k. Alternatively, we can pay closing costs and get a rate of 5.875%. In this case, our total payment would drop by $74/month which would increase our overpayment to $224/month (we’re currently overpaying by $150/month). When all is said and done, this approach would reduce our total mortgage cost by roughly $11k, for a total savings of roughly $23k vs. doing nothing.
Of course, that latter value ignores closing costs. We also have to consider that the mortgage savings really come on the back end, and are thus worth less in future dollars. So… If we assume closing costs of $2k (currently just a guess) and project that amount forward 20 years (that’s roughly when our mortgage will be paid off using the above parameters), compounding at a relatively conservation 5% (and ignoring taxes), our closing costs will be worth $5, 306 in future dollars — well below the additional $11k savings.
The other issue at play here is the near-term future of mortgage rates… According to BankRate.com’s Rate Trend Index, the experts say “Don’t rush to lock. Wait for rates to go down.”
This brings up the possibility of a middle-of-the-road scenario in which we do the no-cost refi right now, and then watch rates and possibly pay closing costs for a rock-bottom rate if they fall in the coming month. Here’s my question for all of you…
What would you do?
(a) Sit tight, watch rates, and do nothing for the time being.
(b) Do the no-cost refi to 6.125% right now, and then watch rates to see if it’s worth acting again.
(c) Pay the costs for the 5.875% and then be done with it (unless, of course, rates tumble dramatically).
(d) Something else that I haven’t thought of…
I’m not running this as a standard poll with checkboxes because I want to encourage everyone to share their thoughts beyond simply picking a letter. Don’t be shy! I want to hear your thoughts!
19 Responses to “More Thoughts About Refinancing Our Mortgage”
Actually, the calculations that I did took those sorts of things into account since it was based on total cost, considering all factors.
Another factor to keep in mind is that as soon as you refinance, the percentage of your regular monthly payment that goes directly to principle instead of interest goes right back to almost 0. I guess the other question you would need to consider is how long you’ve been paying on your current loan, and how much is going towards principle, right?
No cost refi, definitely.
If rates continue to go down, you can refi again. I don’t know if I’d spend any money on a refi at this point, the rate spread is too small and who knows how long you would keep that mortgage.
If closing costs end up being $2,000, it would take over two years to make it up in interest savings.
Did you have a chance to dig up your old paperwork? What about all the recordation fees, taxes, title transfer, blah blah blah that they throw in? Will that add to your bottom line?
Since you mentioned projecting the closing costs out 20 years, I guess you are probably comparing fixed rate mortages. If you are already making extra payments, I would suggest lookign for a 15 year fixed rate or a 7/1 arm.
So you are on a 175k mortgage for 30 years now at 6.375. So that is roughly $1092 a month (P&I). once you add the extra $150, you are up to $1242 a month. Look at 15 year fixed rates. You can get those at about 5.375% (Mortgage Capital Associates and American Federal Mortgage) It will cost you another $150 a month, but then you can get it paid off in 15 years. If this is too much of a stretch, you could do a 20 year fixed rate. That will get you about a 5.625% rate The payment is 50$ under what you are currently paying. Pay that extra $50 and you wil have it paid off in 18.5 years.
I’d actually do something else, which is work out what would be the cheapest over 2 years (closing costs plus interest payments) and then do that – chances are I’ll revisit/refinance the mortgage in a couple of years anyway.
C & D
Refi at no cost, watch rates which probably won’t change enough to do an at cost refi.
Then apply the $74 a month to another savings vehicle such as retirement, 529 for the 4boys, etc.
Not sure what your current situation is with escrow payments (and whether its a big deal) but my comments are directed to that issue. If your bank currently collects, manages and pays your insurance and real estate tax via escrow payments and if you go the no-cost refi are you getting out from under the escrow trap. Last year I earned $300 in interest by managing my own escrow (more than on property and I live in Fla. where insurance is costly). A sometimes bigger issue is that some banks/mortgage companies manipulate escrows to collect late fees, fines, etc. Quote from an article I read – â€œServicing abuse in escrow accounts is the leading cause of premature and wrongful foreclosure.â€
I dont agree at all with Comment by Matt. I am waiting for interest rates to go below 5.5%. The feds have held steady but there is a good chance they will drop and the mortgage market will follow. Its going down even with a feds holding steady. Thats my guess anyway.
C. If I could get that rate, I’d lock it in TODAY. Rates are not going to drop, in the long term…in fact, I’m looking for them to climb dramatically.
We’re in the process of refinancing ourselves. And I’m salivating over the prospect of getting a rate that low.
Pay the closing costs…the lower the rate gets, the more money you’ll be saving. And a few years down the road, when interest rates spike back up to 1970s levels, you’ll be patting yourself on the back for locking in a rate so low the bank will be losing money on you. 🙂
what do you lose by taking advantage of the no-cost refi? it’s certainly better than what you have now, and if rates drop further, you can re-open the issue.
I agree with bankrate on not rushing to lock in, other question i would have is have you shopped around for different companies who might be able to give you an even sweeter deal?
Nickel, since nobody seems to really want to address exactly what you are asking:
I would say find out what the closing costs are going to be, and if they are low enough then go for the 5.8% rate. Most likely, I think that your best bet is probably to take the free refinance option and keep your eye open for rates to drop. You don’t have to put any money up front (and can in fact get an extra large principal payment through since you will have a month w/no actual payment or interest accruals but will still have the money budgeted) and you will have a lower rate. If the rates keep dropping, then you will have an opportunity to pay the closing costs later to save the money. If they don’t, then you will lose out on saving some money, but will still at least save half of that money as opposed to sitting on your thumbs.
Anne: Bach’s approach is payments every two weeks, which equates to one extra payment per year. I understand what you’re saying, but not all banks will apply the bimonthly payments early, thereby saving you the interest.
And this still misses the point of whether or not we should refinance. Some sort of creative payment strategy is great, but the underlying mortgage is what I’m currently grappling with.
@ nickel: “Bachâ€™s approach isnâ€™t actually a magic bullet. All it does is cause you to make an extra payment each year”
I don’t know about Bach’s approach specifically, but if it is what Chee says it is, it’s not simply making an extra payment. That would be the case if he’s talking about biweekly payments (half the mortgage payment every two weeks, for a total of 13 payments in a year). But what Chee is talking about is semimonthly payments (half the mortgage payment twice a calendar month, for a total of 12 payments in a year). From my (admittedly limited) understanding of this approach, it turns into a relatively painless saver because you don’t have to come up with any extra cash, but by making half of your payments 15 days earlier than they’re due, you save a lot of interest.
I’m in exactly the same position as Clever Dude, 2.5 left on a 5/1.
If I were in your shoes however, I would consider the overpayment as a “luxury” item that is technically optional. In the scenario where you take the 5.875% loan and save $74/month, it will take you 27 months to recoup closing costs of $2000. That seems like a long time just to break even, so I think I would wait until a rate drop would put my break-even under 2 years.
There’s no hard & fast rule here, obviously, but I think your magic number is closer to 5.5% than 6.
I personally am waiting for rates to drop, but I have a different motive. I have a 5/1 interest only with 2.5 years left. I don’t want to wait too long to refi to a standard 30 year (if I even choose that type of loan), but we do have a couple years to decide. Alot can happen in 2 years.
I’d say wait for the drop. You’ll still have the option to do a no-cost refi.
Chee: Bach’s approach isn’t actually a magic bullet. All it does is cause you to make an extra payment each year – this is great if you don’t have the discipline to follow through on overpayments. However, we currently add $150 to each payment, which works out to 1.5 extra payments per year (better than Bach’s method). Moreover, this doesn’t address the issue of the refi at all — they’re not even all that related… There’s no reason you can’t do a refi and make overpayments (which is exactly what I’ve outlined doing).
Bottom line: Yes, overpayments save money. But overpayments on a lower mortgage rate save even more money.
I would choose
(d) Something else that I havenâ€™t thought ofâ€¦
David Bach in his great book The Automatic Millionaire shared a great tips about how you can save much more money by automating your mortgage payment..
Let me just share about it here.
You do the half the payment every half month. You can actually save one month payment every year by doing that 😉