With interest rates at historic lows, there seems to be a pretty simple answer. Yes! …Probably.
There is an old rule of thumb that said if you can reduce your interest rate by 1.5%, it is worth refinancing. Loan officers often tell you about the “monthly cash flow savings” from refinancing, calculating that if you’ll save $200/month off your current payment and their fee is $2,400, that you get your “money back” in only 12 months. However, what they sometimes fail to mention is the fact that you’ve often extended the length of your loan to get that cash flow savings. The only savings that really matter is the interest savings you'll reap over the life of the loan.
When we look at refinancing, we want to review the up-front costs versus the interest savings to determine how long you’ll have to own the house to make it worthwhile to refinance. Here is our process:
- Find out the rate and fees of a typical mortgage refinance in just seconds at www.boxhomeloans.com. This way, you’re not wasting the time of your local mortgage broker – even if eventually you’ll go to them for the loan1.
- Look at the amortization schedule projected for the new loan to see when you’ll cross below today’s balance + the closing costs/fees. This gives you the required timeline that you’ll need to own the property to make it worthwhile.
15- or 30-Year Mortgage?
When it comes to selecting between a 15-, 20-, or 30-year mortgage, it really comes down to rate. These days we’ll typically recommend the 30-year mortgage, as the rate is usually only 0.25% more; and you can always make extra payments to pay it off in 15 or 20 years. But paying that extra 0.25% gives you cash flow flexibility, in case you haven’t completed Steps 1-4 in our 4 Simple Steps to Financial Success. If you arrive at Step 5 and still have money left to save & invest, one consideration for Step 5 is to pay down debt – including a low-interest debt; another is to max out your 401(k).
Paying Extra Toward the Mortgage vs. Investing
Some people would rather pay down debt than max out their retirement accounts (Dave Ramsey acolytes for sure). My question to those people is if I could find a 30-year bond to invest in that pays you your mortgage rate (i.e. 2.875%), would you get excited and invest in it? Probably not. But if you pay extra toward your mortgage, that’s exactly what you’re “investing” in. It’s not bad, it’s just not as good as a 401(k) where you can save both federal and state income taxes on all contributions. It would take me ten years to match the tax savings with a 3% mortgage – even if my 401(k) didn’t increase in value!
If you have decent credit, and your primary home mortgage interest rate is higher than 3.5% (as of 2/8/2021), you should look at refinancing if you're planning to own the property for a few years. No one has a crystal ball to know if rates will stay this low forever, or if they could go even lower.
However, if you have other high interest rate debt, you definitely should get started on the process and either pull some equity out of your house to pay down debt, or re-direct your monthly cash flow savings from the refinance toward those higher interest loans.
Reach out to us if you’d like us to review your situation. We’re happy to help.
1. Local loan officers that we trust to work in the best interest of our clients:
- Scappoose/St. Helens and NW Oregon
Guild Mortgage: Pat Olson or Amy Moore (503) 543-9797
- Tucson, Arizona
Fairway Mortgage: Eytan Ben-Yeoshua (949) 331-7614
- Vancouver & SW Washington
Simon Gaskill (360) 798-9290