The Refinance Boom: Should You Refinance Your Mortgage?
Dear Rich Lifer,
Coronavirus has forced the U.S. Federal Reserve to cut interest rates twice this year. The second time (on March 15) set a target federal funds rate to a range of 0 to 0.25 percent.
Since then, the federal funds rate has remained near zero, and the central bank says it won’t raise the rate “until it is confident that the economy has weathered recent events.”
When the Fed cuts rates, mortgage rates fall. This is good news if you’re shopping for an adjustable rate mortgage or home equity line of credit – but bad news if your savings are stashed in money market accounts or U.S. Treasury bonds.
Depending on your financial situation, now could be a good time to consider taking advantage of these low interest rates by tapping into this refinance boom.
Since the early 1990s, there have been several refinance booms. These occur when mortgage rates fall low enough for a large number of homeowners to take advantage and refinance at better rates and terms, saving them thousands of dollars over the life of their loan.
However, events like these often get missed.
In a 2012 Federal Reserve study, researchers concluded that many homeowners failed to capitalize on these refinance booms. Some people thought the savings were too good to be true, while others thought they wouldn’t qualify so they didn’t act.
In any case, the result proved costly. According to the Federal Reserve, among homeowners who did not respond to refinance offers, the median savings passed up were $26,400 over the lifetime of the loan, or about $94 a month.
Freddie Mac ran another study and found the average first-year savings for a $200,000 loan refinanced at the start of 2015 was $2,500. Yet only 1 out of 5 qualified borrowers, who would have benefited from the refinancing, went through with one.
If you missed the last refinance boom, you might still be able to save this time around.
Especially if you heed this urgent warning – and take a few steps to protect and grow your wealth now.
But before you decide anything, let’s make sure you understand the benefits and risks to refinancing.
Top 5 Reasons to Refinance a Mortgage
There are several reasons why refinancing your mortgage is a good idea. However, if you’re soon-to-be retired or already retired, refinancing might not be the right choice given your circumstances.
To better understand if refinancing is right for you, we’re listing some of the most common reasons why someone might refinance and their associated risks.
Here are the top 5 reasons why you should consider refinancing your home mortgage:
1. Lower monthly payments
The U.S. Bureau of Labor Statistics estimates the typical American aged 65 and older spent an average of 34.5 percent of their household income on housing annually from 2018-2019.
If you refinance for another 30- or 15-year term, you can lower your monthly payments and free up room in your budget. This can be a lifesaver if cash flow is tight.
If you’re not yet retired and your nest egg is small, you can use these lower monthly payments to begin saving more money leading up to retirement.
The downside to lowering your monthly payments, however, is that your term will reset, so if you’re 8 years into a 15-year mortgage and you decide to refinance to lower your monthly payments, your 15 years will reset, and you’ll pay a lot more in total interest.
2. Lower interest rate
This should be obvious, but refinancing your mortgage to take advantage of lower interest rates could save you tens of thousands of dollars over the life of your loan if you time it right.
When you’ve only had your loan for a few years, and interest rates drop, you can typically lock in the lower interest rate with a shorter term. This saves you big time over the lifetime of your loan.
But if you’ve had your loan for more than a few years, you might not save in the long run. So, it’s best to run the numbers and use a refinancing calculator to see if you’re actually saving in the end.
3. Switch to a fixed rate
If your original loan is an adjustable-rate mortgage and your initial fixed term is about to expire, you may want to refinance to a fixed-rate mortgage.
Locking in a rate can protect you from rising interest rates in the future. And having the same principal and interest payment every month is easier to plan and budget for, which can be a real stress reliever for a lot of retirees. Plus, it’s important to remember you can refinance for fewer than 30 years.
But if rates continue to drop, you won’t be able to take advantage without going through another refinance.
4. Reduce your loan term
If you’re less than five years away from retirement, shortening your loan term can be a smart move to accelerate paying down your mortgage. This way you can start retirement mortgage-free without having to worry about interest payments.
The drawback to reducing your loan term is that you end up increasing your monthly payments to be able to pay off your loan faster, which can add a lot of stress if cash flow is tight or your income is unpredictable.
5. Cash-out refinance
An alternative to a home equity loan, is refinancing and cashing out a portion of your home equity. This allows you to access a large chunk of money without selling your home.
You can use this cash to help pay for a grandchild’s college education, start a business, or invest the money back into your home through renovations and upgrades.
The tradeoff is the cash you take out will cost you more interest over the life of your loan, but not necessarily more than other financing options would cost you.
And, if you find that refinancing your home doesn’t make sense for your circumstances, there are other ways to build your wealth – especially if you act now.
The last thing you must factor in are closing costs. When you refinance a mortgage, you’re taking out a new loan to pay off and replace your old one. Most banks and lenders charge fees to close on the new loan.
If you’re thinking about taking out a new home loan to access the low mortgage refinance rates, it’s important to know if you can afford to pay these closing costs upfront or whether you have to roll these costs into your new loan.
If you’re in the latter group, you’ll need to calculate your break-even point — the point at which you will have paid off your closing costs and start to see real savings. Then you need to decide whether that timeframe matches up with the timeframe you have in mind for your home.
For example, if your closing costs take five years to break even, but you plan to sell your home in five years or less, it may not be worth refinancing, despite the low interest rates.
However, if you decide to stay in your home for longer than five years, taking advantage of the record-low rates could be worth your while.
The bottom line is refinancing your home can be a great way to free up some extra money in your life, but the pros must outweigh the cons.
To a richer life,
The Rich Life Roadmap Team