Refinancing a mortgage is a big deal.
You can potentially save hundreds of dollars a month, and tens of thousands over the life of your loan.
After several years of rising rates, we’ve seen a reversal. Rates have come down substantially in a short period of time, and they’re the lowest they’ve been since 2016.
So is now the right time to pull the trigger?
It could be.
Why are rates so low?
Mortgage interest rates can be impacted by a number of different factors including yields on mortgage-backed securities, the overall conditions in the bond market, basic supply and demand, economic growth, inflation and monetary policy, said Charles Pawlik, a certified financial planner and chartered financial analyst with Beacon Trust in Morristown.
One example – although not the only factor – is the sharp decrease in the interest rate on the 10-year U.S. Treasury Bond, Pawlik said.
At this writing, it stood at 1.70 percent while it was as high as 2.79 percent in January and 2.13 percent just last month.
“This is due to the large demand for Treasuries from nervous investors that are rushing into safe-haven investments like the 10-year U.S. Treasury in the midst of an uncertain and volatile backdrop in the equity markets, driven in large part by the escalation of the trade war with China,” Pawlik said.
Yields on mortgage-backed securities – which can also be viewed as safe-haven investments and more directly influence mortgage rates – have also come down, he said.
“Yields move in the opposite direction of bond values, and the increased demand for Treasuries and mortgage-backed securities has pushed bond values up, and consequently, has pushed yields down, leading to lower mortgage rates,” he said.
How can I decide if it’s time to refinance?
First and foremost, make sure you understand the goal you have for the refinance. This is what will help you determine if the benefits outweigh the costs.
For example, you may be trying to lower your monthly payment or shorten the term of your loan.
Either way, you’re going to need to calculate your break even point, said Claudia Mott, a certified financial planner with Epona Financial Solutions in Basking Ridge.
Your break even point is the point at which your savings on a refinance are greater than the closing costs.
Let’s take this simple example. Say it will cost $2,500 to refinance your loan, and the new mortgage will give you a savings of $100 per month. You’d have to stay in your home for 25 months to get back the $2,500 you paid in closing costs. That’s your break even point.
The longer you plan to stay in your home, the more likely refinancing is a good idea.
If you’re near the end of your current mortgage, the majority of your payment is going to principal and the interest savings from refinancing may not cover the costs of refinancing, said Jim McCarthy, a certified financial planner with Directional Wealth Management in Rockaway.
“Conversely, if you are in the early stage of your mortgage – say the first 10 years – then refinancing is probably a good option as more of your payment is still going to interest, rather than principal,” McCarthy said.
An often cited general rule of thumb is that you should refinance if you can get an interest rate that’s at least 1 percent lower than your current rate, Pawlik said.
But in reality, you have to go through all the numbers and determine your break even point to make an informed decision.
Should I roll my home equity line into the refinance?
Prior to 2017, interest from debt on a residence could be deducted whether it was from a mortgage or home equity line of credit (HELOC).
But under the new tax law, interest on HELOCs can only be deducted if the loan was used for a significant home improvement, Mott said.
“The interest paid on a HELOC that was used to consolidate debt, fund a great vacation or pay for college is no longer deductible under IRS rules,” she said.
That means rolling your HELOC into the refinance could impact how you deduct the interest on your new loan.
“If the HELOC was not used for a qualifying purpose under the eyes of the IRS, then the fraction of the interest that it represents must be removed from the amount deducted,” Mott said.
Also under the new tax law, how much home debt you can deduct changed.
Married couples can deduct mortgage-related interest on up to $750,000 of qualified home loan debt, and it’s $375,000 for separate filers, Pawlik said. If the debt was taken on before Dec. 15, 2017, you can deduct interest on up to $1 million of qualified home loan debt for married couples and $500,000 for separate filers.
Pawlik said it’s important to consider the higher standard deductions that are now in place – $24,000 for a married couple and $12,000 for single filers.
“The interest on your HELOC along with your other itemized deductions would need to be in excess of the higher standard deduction for the deductibility of HELOC interest to be a relevant factor in your decision,” Pawlik said.
What about 15- or 20-year vs. 30-year fixed rate loans?
McCarthy said he generally recommends going with a 30-year fixed rate loan instead of a loan with a shorter term for two reasons.
First, the 30-year gives you a lower monthly required payment.
“The current difference in interest rates between 15-year and 30-year fixed rates loans isn’t big enough to justify taking on the burden of a significantly higher monthly payment,” he said. “If the homeowner wants to pay the mortgage off sooner, they can always pay more than the 30-year fixed payment and indicate the excess should be applied to principal.”
What should I expect with closing costs and should I roll them into the loan?
There are many fees and charges associated with a mortgage refinance, including an application fee, appraisal fee, costs for a credit check, mortgage origination and recording fees, title searches and more.
It’s common that lenders will ask you to pay for the appraisal and credit check fees upfront, and they offer to roll the other closing costs into your loan. If you’re cash-poor, that can be tempting, but there are downsides.
“Overall, the cost to refinance can run from 2 to 4 percent of the value of the loan,” Mott said. “If possible, having the cash on hand to cover these expenses is preferable to including them in the loan so that additional interest isn’t paid over the lifetime of the loan.”
Beware of lenders who advertise “no closing cost” loans, Pawlik said.
“There are fees associated with refinancing, and whether it is by way of a higher interest rate or adding the closing costs to your mortgage balance, the lender is collecting those fees one way or another,” he said.
Remember that if you pay your property taxes and insurance through your mortgage, you’re going to have to fund your new escrow account upfront. You can’t simply transfer the funds from your old escrow account to the new one, and you’ll eventually get a check for the balance of the old account.