by Aaron Staufer
NMLS: 501268 | LMB: 717246
No doubt you’ve been seeing commercials on TV or hearing radio spots advertising rates that seemingly can’t exist and you’re wise to be a bit skeptical. At the end of the commercial you’ll undoubtedly see a screen of text in .2 font that can hardly be read. So how do you know when it makes sense to refinance and what should you look out for? I’m taking a bit of time to hit the high points…
One of the first things I ask a member when we start the refinance conversation is, “how long do you plan on being in the property for?” and the second question I ask is, “what do you intend to do with the property once you move out?”
Refinances always have closing costs, sometimes they are rolled into the loan amount and sometimes they are wrapped into a higher rate, but rest assured they always exist. If somebody is only going to be in the house for a year or two and they are planning on selling after that time, refinances rarely make sense. The longer that you have the loan, the longer you’ll benefit from reducing the rate or term. So if you’re thinking about moving soon and you don’t have interest in being a landlord then you’ll want to think long and hard before paying the costs associated with a refinance.
Another important variable is to consider how much you owe. Closing costs on a refinance are fairly static. The difference in closing costs for a $100,000 mortgage and a $500,000 mortgage are typically only a couple hundred dollars. But somebody with a $100,000 mortgage is going to save 1/5th the amount of somebody with a $500,000 mortgage. Since the costs are almost identical in both scenarios the larger mortgage is going break even with costs in far less time. If you don’t owe a lot expect your break even point to be quite a bit higher. Owing less money is a great problem to have but it can pose a problem when it comes to refinancing.
Make sure when you’re hearing about refinances that you keep an eye on a few things.
1) The term of the loan. I see commercials all the time and my poor wife has to listen to me rant and rave every time one comes on TV because you’ll hear them advertising, “2.5% with no points!” but if you read the fine print you’ll see the rate that’s being advertised is for a 15 year mortgage. It’s not that 15 year mortgages are bad (I love 15 year mortgages) but if your goal is to reduce your payment there’s a good chance that loan will not accomplish your objective.
2) The costs associated with the rate that’s being offered. Points are a bit confusing but in short 1 point (also known as discount points) is 1% of your loan amount. Points are the cost (or credit) associated with the rate that’s being advertised. You can pay higher costs (points) and obtain a lower rate. It’s extremely common for lenders to advertise rates with points being paid. Keep an eye on the costs associated with the refinance and as your lender for a “no point option” for comparison sake. A loan officers’ job is to present options, not to decide for you.
3) The program they are advertising. Another common ploy lenders will use is they will advertise programs that are seldom used because they have a lower interest rate. The next time you see one of those commercials on TV see if the letters “FHA” show up anywhere. If so, the program that’s being advertised is a Government loan that has a multitude of potential down sides. Just as 15 year mortgages aren’t bad nor are FHA loans. They have their place in the world and can be quite helpful for the right situation. But if you have good credit or 20% or more equity in your house then FHA is not a program we’d typically explore. It has higher costs both up front (known as up front mortgage insurance) as well as on a monthly basis (monthly mortgage insurance). While they may come with a lower rate the potentially higher upfront and monthly costs usually outweigh the benefit.
If you’re going to have the loan for an extended period of time and you can recoup the costs associated in short order (I usually hope for 18 months or less though it does depend case by case) then a refinance may very well make sense. Keep an eye out for misleading advertising and make sure you’re working with a reputable lender.
Ask for a Loan Estimate or Closing Cost Worksheet to ensure you’re getting a full break down of the costs associated and make sure to read the fine print!