The possibility of a lower monthly house payment would be welcome by any homeowner, but lower payments aren’t always what they seem. And what about those are not in a position to refinance, are they out of luck?
Some may be better off for not refinancing. Refinancing, even for a lower rate and payment, isn’t always the bargain it seems to be. There are some elements of refinances that lenders can and do massage in order to make refinances more appealing than they really are.
Now as a former mortgage originator, I’m fully aware of the math calculations used to compute the viability of a refinance. Top of the list is the “closing cost recapture period” — dividing the upfront cost of the refinance by the monthly savings to determine how many months it will take to recapture those costs before true savings are achieved. (The “standard” is usually 24-36 months.)
But I’d argue that in the very different housing market and uncertain economy we now find ourselves with factors beyond math calculations that have to be considered.
One of the ways homeowners lower their payments in a refinance is by extending their loan term. A longer term translates to lower payments because the principal repayment is spread out over more years.
Let’s say that you’re currently ten years into a 30 year loan — you have 20 years left to pay. If you refinance your mortgage and in the process reset the loan back to 30 years, you will lower your payment, but you’ll add another ten years of payments to your loan.
If you do refinance, make sure the term of the new loan matches the remaining term of your existing mortgage, otherwise you may be at least partially buying your lower payment by adding many years of payments on the back end of the loan.
Extending the loan term is common with refinances, and can give the appearance of greater savings than is actually true.
A former mortgage customer of mine recently called about refinancing his mortgage. After explaining that I was in “mortgage refugee retirement,” he said that he had been approached by a lender who was offering an extremely low rate for him to refinance. But there was a catch: on a loan amount of just over $200,000 he would pay $8,000 in closing costs and another $6,000 for prepaid taxes and insurance.
In order to get his ridiculously low rate, he’d have to incur upfront costs totaling $14,000. Now like a lot of homeowners, he didn’t have the spare $14,000 in order to complete his refinance “investment”. The lenders solution? Add the closing costs and prepaid expenses to his new loan balance. He goes in owing $200,000 and comes out owing $214,000—does that sound like a good deal?
This is standard operating procedure in the mortgage world—sell the homeowner on rate and payment. If you’re also a rate-and-payment junkie, keep a couple of things in mind. First, the borrower is sacrificing equity in a declining market; second, should selling his home become necessary, he will be impaired by this transaction.
Never be anxious to “buy” a lower rate with a higher loan balance. The housing market of the past few years has left homeowners needing to protect equity as much as anything else.
Oh, and in case you’re interested, my former customer didn’t do the refinance.
Changes in the mortgage lending industry—as well as declining equity—have made it difficult or even impossible for many homeowners to even qualify for a refinance. If you’re one of those who can’t get a loan, don’t fret. There is another way–want to know what it is?
Painfully simple and definitely “old school”, it was how people handled their mortgages until about a generation ago. Maybe you can’t pay it off right now, but you can accelerate the payments and pay it off much quicker than you think.
Use a mortgage amortization tool to see how much more quickly you can eliminate your mortgage with just a little bit of extra money paid each month. And since this is income tax filing time, you can get a jump on the process by using part or all of your tax refund to paying your mortgage down. Using a combination of tax refund money and extra monthly payments will move it even faster.
And here’s a bonus: as your mortgage balance declines the interest charge will drop too. High interest rates don’t seem so high when the amount of money owed is lower.
What’s often misunderstood about mortgages is that the ultimate goal is to pay them off and to own your home free and clear (Proverbs 22:7). But in the past few decades it’s become a shell game we play, turning mortgages into perpetual debt in the quest for lower payments, debt consolidations, and equity cash-outs. Lenders love this game too. Their goal is to keep us in debt—that’s how they make their money.
Our goal should be to keep that from happening.
Have you ever refinanced? Was it a good decision for you? When is the right time to refinance? Leave your thoughts in the comments section below.