Should you Refinance? – When Saving Money a Bad Thing!

Is it possible that saving hundreds of dollars a month is a bad thing? Mortgage rates continue to remain at a historic low. However, Freddie Mac, one of the major buyers of mortgages, has stated that rates can’t get much lower. With a government imposed half percent rise in refinance fees coming soon, I believe we are at the rock-bottom of refinance rates. Many homeowners have a rate higher than what is currently being offered. This leads to the question, when does it make sense to refinance? Should you look at the monthly savings or some other calculation to help make this decision?
One old rule of thumb was that any time you could decrease your rate by 1% you should refinance. However, that rule of thumb was formed at a time when the average home cost around $100,000. A timelier rule of thumb is that the cost of the refinance should be recaptured within 36 months based on the monthly payment savings. This method leaves a lot to be desired because in most cases the monthly payment will drop, saving money monthly simply due to the fact you are spreading out what is owed over a new 30-year term. This is not a true savings but simply a loan recast that may actually cost you more money in the long run. This method will also not work if you are refinancing into a shorter term loan to accelerate a payoff.
My theory is that you should refinance only if you can recoup the cost of the refinance in 36 months based on the interest savings (not the payment savings). The calculations are a little more complicated, but you calculate the amount of interest you will pay on your current mortgage for the next 36 months. You then calculate the interest you will pay for 36 months on the new mortgage. The difference between the two numbers should be less than the cost to refinance. As an example, if you have a mortgage of $250,000 at 3%, you are paying about $22,500 in interest over 36 months. If you were to refinance that $250,000 at 2.5%, you would pay $18,750 in interest over the first 36 months, saving $3,750 in interest costs. Therefore, if the cost to refinance is less than $3,750, the refinance makes sense.
The great thing about using interest saved rather than monthly payment savings to decide if a refinance is right for you is that you can use this method when shortening the term of the loan, which may have a higher payment. Many homeowners are taking advantage of much shorter loan terms now, and not just the standard 20, 15, or 10-year terms. My company now offers custom terms that allows you to pick your term; anything from 30 years on down. Want a 27-year term? I have that! How about 18 years? I have that too. Choosing your loan term allows you to refinance without having to extend your mortgage payoff date. This allows you to save money in interest and possibly get out of debt sooner.
Refinancing has gotten a lot easier with more than half of my clients getting an appraisal waiver. If you would like me to run some numbers, I would be more than happy to. Just send me a quick email with your current balance, current interest rate, and the term you would like. I will run some numbers for you and give you the break even.