If that's not enough of a reminder, the mortgage industry is one of the biggest advertisers around, pushing the supposed ease of refinancing with online "speedy mortgages" and the like. But before you decide to pursue a refi, ask yourself:
How long do you plan to stay in the house?
The old rule of thumb was that you need to be there for at least two to three years to justify the costs of obtaining the new loan - but, each situation is different and you really have to run the numbers. In the current low-rate environment, the old rules may not apply because most existing mortgage interest rates are so low in the first place. While you may plan to stay in your house forever, ask yourself, if your income or job situation changed, or if a family emergency were to arise, would you need to move?
How long you plan to stay is a key factor affecting whether the interest rate on your new loan is low enough to justify the costs and trouble of refinancing. Another perspective: How many months of savings on the reduced mortgage payment resulting from the refi would it take to earn back the expenses of the new loan?
For many, the answer today is many months - perhaps more months than you want to have a mortgage, considering that your present mortgage would generally be paid off much sooner than the new one. Before the 2007-2008 financial crisis, 30-year fixed-mortgage rates were in the 5- to 6-percent range. So in the last five years or so, almost anyone with good credit and equity who took out a mortgage in the previous decade was able to refinance their rate down by as much as two percentage points, resulting in a substantial savings in monthly payments.
But in today's low-rate environment, with many existing mortgages set at a rate not much higher than 4 percent, this kind of rate reduction isn't possible. So there's not as much room for a substantial savings in your monthly payment.
You should view these savings through the lens of the seven to nine years Americans typically stay in their homes. Of course, how much of a difference a refi would make depends on when you got your mortgage, how big it was, and the rate you could get now with your income and credit. In the past, when rates were higher, it usually made sense to refi if you could shave two percentage points off your interest rate. You can do the math with one of the many online mortgage calculators available.
One way to improve your rate, even when prevailing rates aren't declining, is to change from a 30-year mortgage to a 15-year loan. Rates on these shorter mortgages tend to be lower, but this will probably increase your payment. However, you will pay off your mortgage much sooner, saving a lot of interest and potentially freeing up this money for paying expenses during retirement.
If you had to move unexpectedly, could you cover the new mortgage payments by renting out the house?
You may not want to be in the rental business, but you never know what life will bring. You could lose your job and find a new one in another area, or you might have to move for family reasons. Selling homes quickly isn't easy - even in the best of markets and locales - because real estate is an illiquid asset and takes time to sell.
I have a client who had a strong bias against renting her house, but after making a year and a half of payments on an empty house, all the while having to pay the mortgage on her new home, her anti-renting bias evaporated. At that point, she was willing to do anything to cover the payments and stop hemorrhaging money needlessly. Having an honest discussion with yourself could save a lot of anguish and cash down the road.
So before you refi, it's a good idea to compare rents for comparable dwellings in your neighborhood to the new mortgage payment. If there's a shortfall, you might want to reconsider refinancing. Sure, your new mortgage payment might be less than what you're paying on your current loan. But you've already paid the costs for that loan. If you can't cover the mortgage with the rent, the difference would put you that much further in the hole.
Are the homes in your neighborhood increasing in value?
If not, refinancing would mean extending your commitment of indebtedness in a neighborhood that may not deliver the appreciation needed to justify getting a new loan.
How much will any cash that you'd have to put down on the new loan lower your cash reserves?
Homeowners need good cash reserves to maintain the property, do repairs and make mortgage payments in case of job or income loss. Significantly lowering these reserves just to save a little every month on your mortgage payment generally isn't a good idea, given the cost of money and the inability of people in dire straits to get loans. These cash reserves are critical for maintaining your home and protecting your investment in it. So it's important to know how much - by what percentage - these costs would lower your cash reserves.
What's the condition of your home?
When will it need a new roof, air conditioner, hot water heater or appliances? When will it need exterior repairs or painting? Are there any deferred maintenance issues that might soon arise, causing you to spend your cash on hand? If so, you should think twice before giving that money to the mortgage company for a refinance. Make sure you have a plan to cover repairs until you can replenish the cash reserves they might consume.
By asking yourself these five questions and exploring the nuances of the answers, you can constructively explore the issue of whether it's a good idea to seek refinancing.
Any opinions expressed in this column are solely those of the author.
Byron L. Studdard is founder and president of Studdard Financial, LLC, a fee-only financial advisory firm based in Sarasota, Florida. Studdard has been listed in the Guide to America's Best Financial Planners published by the Consumers' Research Council of America, an independent research organization. He can be reached at Byron@studdardfinancial.com.