Mortgage rates are low . . . very low! In fact, 30-year fixed mortgage rates have been below or near 4 percent for several months. Often, it makes great financial sense to refinance your home at the lower rates. After all, who wouldn’t want to save a few bucks?
However, before you make the call to “1-800 GET-ME-A-GREAT-RATE,” you need to consider all the costs and fees that go into refinancing your home. The closing costs can get pretty steep, as there are many fees associated with getting that great new 30-year rate, such as: origination charges (sometimes referred to as “points”), an appraisal fee, title insurance, recording charges, transfer taxes, etc. On a $417,000 mortgage, these fees can total about $5,500. Despite these expenses, refinancing to a lower rate may still be the smart move.
The next step is to consider how long you intend to stay in your house and then calculate the “payback.” In other words, how long does it take to pay back the closing costs when you consider the monthly savings with new lower mortgage payment verses the original mortgage payment? For example, the closing costs on a $417,000 30-year, fixed-rate mortgage at 3.875 percent is $5,500, with a new monthly payment of $1,961. The old mortgage payment was $2,238, which means the homeowner will save $277 per month. The closing costs of $5,500 divided by the monthly savings of $277 equates to a payback period of nearly 20 months. So, if you are going to be in the house longer than that, it’s a good deal. However, if a potential move is in your future, you may want to stay with your current mortgage.
Let’s consider the facts about home ownership and how long people typically remain in their homes. This is, in fact, one of the questions the U.S. Census Bureau asked in its 2007 American Community Survey. Only 74 percent of average single-family homeowners are still in their home after five years. This means that one out of four families had moved! The move-out rate is even higher for multi-family condo owners. One out of two families had moved out after five years!
Next, let’s take a look at the 30-year amortization table that is often provided in your mortgage closing documents. This is the one that you quickly glanced over as you were signing your legal name 39 times (don’t forget your middle initial). Okay, you went with the 30-year, fixed-rate mortgage, you got a great rate of 3.875 percent, and you paid the closing costs. Since you intend to be in the house for a long time, it’s a smart move.
Now, fast forward five years, and it’s time to move (hey, you got a promotion; good things can happen!). The big question is: How much principal have you worked off over the last five years? You’ve been paying the mortgage company $1,961 per month, which equates to more than $117,000 over five long years. During this five-year period, only $40,542 has gone to principal, and a whopping $77,058 has gone to interest! Yes, the mortgage company has applied about 65 percent of your payments to interest! Lenders lend money to make a profit on the interest, and mortgages can be very profitable—especially in the first half of the term, when most of the interest is being paid. Also, they know that most families will not stay in their homes for the full term.
If you are one of those families that wants to pay down the mortgage principal faster while also building more equity, consider a bi-weekly mortgage payment. Simply stated, take your monthly mortgage payment and divide it in half. Then pay your mortgage company that payment every two weeks. You make 26 payments per year, which is the equivalent of 13 monthly payments rather than 12. The extra payment should be taken directly off the principal, which will reduce your payment schedule accordingly, and you will pay off your mortgage in about 21 years! Many mortgage companies offer a bi-weekly payment option, and it’s even possible to convert your current monthly payments into a bi-weekly schedule.
Dean J. Catino, CFP®, CPRC, is a managing director and cofounder of Monument Wealth Management in Alexandria, VA., a full-service investment and wealth management firm. Monument Wealth Management is backed by LPL Financial, an independent broker-dealer. Securities and financial planning offered through LPL Financial, a Registered Investment Advisor, member FINRA/SIPC. Follow Dean and Monument Wealth Management on their blog Off The Wall and on Twitter at @MonumentWealth and @DeanJCatino. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for individuals. To determine which investment is appropriate please consult your financial advisor prior to investing.