By: Daniel P. Simpson
Interest rates have hit the lowest point experienced by our generation and may go lower. These low rates give everyone an opportunity to lower the cost of carrying existing mortgage debt or to increase liquidity by increasing mortgage debt.
The financial analysis to determine whether or not it makes sense to refinance depends upon many factors, including the existing mortgage balance and interest rate, the new interest rate, how many years remain on your existing mortgage, how long you intend to own your home, and the cost to refinance. The table which follows illustrates the savings in year one, and over the life of the loan, by refinancing an existing 20-year, $200,000 mortgage currently at 7% or 8% with a new 6%, 20-year mortgage. Both cases assume you are at or near the beginning of the loan term on the existing mortgage.
$200,000 loan, 20 years
| Item | Existing Mortgage@ 8% | Existing Mortgage@ 7% | New Mortgage@ 6% |
|---|---|---|---|
| Monthly Payment | $ 1,672 | $ 1,550 | $ 1,432 |
| Payments over life of loan | $401,353 | $371,988 | $343,711 |
| Savings @ 6% | $ 57,642 | $ 28,277 | |
| Interest first year Savings @ 6% | $ 16,000$ 4,000 (1st year) | $ 14,000$ 2,000 (1st year) | $ 12,000 |
In the examples above, in the first year, refinancing an 8% mortgage at 6% would save $4,000 and refinancing a 7% mortgage at 6% would save $2,000.
Over the life of the loan (a total of 240 monthly payments), the total savings from refinancing a 7% mortgage at 6% would be $28,276 and the savings from refinancing an 8% mortgage at 6% would be $57,641.
The approximate costs to refinance with a new $200,000 mortgage are as follows:
| Item | Cost |
|---|---|
| Application/Appraisal fees | $400-$1000 |
| Title insurance and Searches | $725 |
| Legal Fee | $500 |
Of course, if your loan commitment includes a requirement to pay a point or points (often called a commitment fee), that would be added to your cost. Under certain circumstances your lender may require a new survey (such as where an addition has been added since the last survey); that would typically increase your costs by another $500 or so.
Using our example, even if you refinance a 7% mortgage at 6%, you would recover all of the costs in the first year and would save ten times that amount over the life of the loan. With larger mortgage balances the savings are more dramatic and with smaller mortgage balances the savings are more modest. In most cases, if you can obtain a 1% reduction in your interest rate, you should seriously consider refinancing.
If you do contact lenders, pay particular attention to your protection, or lack thereof, if interest rates move up or down between application and closing. With some lenders you may be able to lock-in a rate in advance. However, if rates go down you may or may not be entitled to a “float down” to the new rate at closing. Remember also, as a last resort, if the rates really move down, you can always rescind the transaction within three days after the closing and start the process over with another lender, losing only your up-front application and appraisal fees.
This publication is intended for general information purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how the law may apply to specific situations.