This blog is actually the second part of my first blog called, “How Does Refinancing Work.” If you haven’t read that one, please do, the link is here (https://realestateofhawaii.com/real-estate-blog/how-does-refinancing-a-mortgage-work/)
In Part 1, I spoke in general about how refinancing your home works. Now let’s get into if now is the right time to do it.
I tend to find that the decision to refinance is a little more cut and dry for people who are doing a cash out refinance or changing the rate type say from an adjustable rate mortgage to a fixed rate mortgage. It’s often times when the homeowners are trying to reduce their interest rate or payment terms that they are on the fence and ask me for my thoughts. Here are 2 important tools to use when deciding to refinance:
Tool #1 Break Even Points:
If you recall in Part 1 of the refinance blog, I mentioned break even points. This is probably the simplest cash flow tool to help you decide to refinance to a lower rate. If you refinance, you’ll incur closing costs for the new loan. Calculating your break-even point will determine how long it will take for you to recoup those closing costs in the form of smaller monthly payments compared to if you were to just keep your old loan. So basically, using this break-even point calculation, as long as plan to keep your new loan past the break-even point, it makes sense to refinance. On top of that, the longer you keep that new mortgage, the more you’ll be saving. Here’s an example of an online refinancing calculator that let’s you know the break even point (https://www.realtor.com/mortgage/tools/refinance-calculator/). This is purely a simply quantitative calculation and does not take into consideration the time and effort for you to go through the process of refinancing. To some people, they don’t mind, but to others it’s kind of a pain in the butt. So that’s up to you how you value your time. For my wife, there’s definitely a threshold of savings we’d need to get to make sense for us to go through all the hoops to refinance a mortgage.
Another thing to keep in mind is that if you are refinancing from a 30-year mortgage to another 30 year mortgage, you’re actually extending out your mortgage. Some lenders have flexible terms, 20 year or even odd number of years, so inquire with them about that if you’re concerned about extending the life of your loan and try to match the number of years you have remaining in your old loan with your refinanced loan.
Tool #2 Amortization Tables:
If you are refinancing to a lower term, say to move to a 15 year mortgage, then the break-even point method may not make sense, mainly because the primary reason to shorten the term would NOT be to increase cash flow but decrease the amount of interest you pay over the life of the loan. In this scenario, I’d recommend comparing amortization tables to see the difference in interest payments to quantify your savings and determine if you should refinance or not. Amortization tables or schedules detail out the payments for the entire life of your loan and how much of the payments are going to interest or to pay down the principal. You can get these from your lender or easily recreate for your old loans with online calculators. Here’s a link to one amortization schedule calculator (https://www.amortization-calc.com/).
The amortization table will show you how much faster you’ll be building your equity because more of your monthly payments will be going to pay the principle of your loan. You can run scenarios to determine how much interest vs principal you would have paid in 5 years or 10 years from now and compare the difference if you had refinanced or not and decide from there. Like the break-even point calculation, a big part of the decision is how much longer you intend to hold the property and the loan.
Don’t forget you also have the two alternatives to refinancing I mentioned in the last video of a Home Equity Line of Credit and Recasting your mortgage to lower monthly payments.
I can’t end this blog without mentioning the “refinancing rule of thumb” that was used in the past. This rule stated that if you can get a 1% decrease in your stated interest rate, then you should refinance. I think that was applicable in the past when we were comparing existing mortgages of 5+ percent. These days we are looking to move to get rates possibly below 3%. As such, that 1% rule may not apply as a 1% delta back then is not comparable to a 1% delta today. So, I personally don’t think this rule of thumb is applicable in today’s interest environment.
Every situation is different but hopefully either or both tools mentioned here facilitate your decision. You can always reach out and bounce your situation off of me and we can talk through it. Good luck!!!
