Refinancing is Worth a Look

Hey Paul: What do you think will happen to mortgage rates this summer? We have a 30-year mortgage that we have 22 years left paying on. Our mortgage rate is 4.75%. Should we refinance our home?

 The refinance question comes up a lot and there are certainly plenty of blogs and mortgage calculator apps out there to help you answer your question. But like always, who do you trust? Well hopefully you can at least think about trusting what I have to say as I don’t have a skin in the game.

Let’s start with a few mortgage myths.

Myth #1: Mortgages are “good debt”. No, there is no such thing as good debt just as there is no such thing as a good cancer or good divorce. Yes, it’s better than credit card debt as you have a home as collateral and the rate is reasonable but a mortgage is a liability not an asset.

Myth #2: Since mortgage interest is deductible the rate is quite a bit lower than the stated rate. The simplest example of this is a 4% mortgage rate for someone in the 25% tax bracket. If they have enough other deductions such as state income taxes, property taxes and charitable giving to surpass the standard deduction than this myth has some validity. However most middle-income households do not get the full deduction impact from their mortgage as they simply don’t have enough other deductions.

Myth #3: It is always better to have a 15-year rather than 30-year mortgage if you can afford the higher payments. This actually has some truth to it as you’ll get about a 1% lower rate and obviously be freed up from mortgage debt in half the time. The fact is that you if (and this is a big if ) you can earn the same rate on investments as your mortgage rate then at the end of three decades you will have exactly the same wealth no matter what term you choose for your mortgage.

Myth #4: If you refinance you have to restart over at 30 years or fit into one of the standard length terms like 15 or 20 years. Not so. In your case you could go with a 15-year mortgage but the payments may be more than you can comfortably handle. An alternative is to go with a 30-year mortgage but immediately pay down the balance to leave only 22 years remaining while keeping the monthly payment at the scheduled rate. Another method is to pay extra each month to pay down the balance faster. The lender can tell you this amount – or I’ll calculate it for you.

Is this the lowest rate we can expect or will they drop even lower in the next few months? My hunch (and keep in mind the track record of economists making predictions) is that right now is as good as it will get. I’m surprised rates have hung around this long at historic lows.

For your 4.75% mortgage you can expect to knock about a percentage point off your rate with a new 30-year mortgage. A 15-year mortgage rate is almost 2% points lower – if the finances (and wife) are alright with it consider chopping seven years off the housing debt schedule. Of course the best rates are for those with excellent credit and the income capacity. If your credit or earnings have taken a hit since your original mortgage then you may not be able to lower your rate with refinancing.

There are at least a couple local lenders who have very reasonable refinancing costs. Suppose your closing costs (e.g. appraisal, title work, etc.) are only $500. This probably means the bank is eating some of the costs. If you have a $150,000 mortgage balance then a 1% rate saving will roughly save you $1500 of interest expense in the first year. So in about four months you have recouped your refinancing costs and your mortgage will be about $90 less per month.

Any local bank can provide you with a good faith estimate of the costs. If you have any “special circumstances” then working with a local lender is usually beneficial. If you don’t mind dealing online then go through BankRate.com or Zillow.com to search for the best deals nationally. I wish the best in your mortgage journey.

Dr. Paul Hamilton is an Associate Professor of Economics at Asbury University and a CFP providing fee-only financial advice. He is available to provide free workshops to churches, local businesses and other groups.

 Contact him at Paul.Hamilton@Asbury.edu or www.USA-Economics.com