By Steven C. Merrell
Q: I have been thinking about refinancing my mortgage for several months. Just when I was about to lock in my rate a few months ago, the mortgage company said my rate increased from 2.75% to 2.875% so I backed away. A few weeks later the rate went up to 3.25% and I felt bad for waiting. Now rates have dropped a little bit and I’m thinking about refinancing again. Here’s my question: should I lock in my rate now or wait for them to drop further?
A: I’m sorry, but you ask a question that is impossible to answer. I have no idea where interest rates will be tomorrow or next week or next month and anybody who tells you differently is probably trying to sell you something. A better question to ask might be if it makes sense to refinance at the current market rate or not. A related question to consider is whether or not a small change in rates makes a big difference in your overall financial picture. In both cases, I don’t think the difference between 2.875% and 3.125% is going to have a big impact on your future.
The decision to refinance is a straightforward question about much the refinancing will save you over time compared to what the refinancing will cost you right now. If the refinancing will save you more than it costs, then refinancing will improve your wealth position. However, if the cost of refinancing is higher than the amount you expect to save, refinancing will actually reduce your overall wealth position and should be avoided even if rates are low and all your friends are refinancing.
When you refinance a mortgage, certain costs are non-recurring, meaning you pay them only once at the time the loan is closed. Non-recurring costs include items such as fees paid for processing the loan, a real estate appraisal, title company services, credit reports, notary services, etc. Altogether, non-recurring fees typically run somewhere around $4,500 regardless of loan size.
Non-recurring costs are the costs you care about when you are considering refinancing your mortgage. Before you commit yourself to refinancing, you should ask your mortgage banker for a detailed estimate of the non-recurring costs involved. An ethical mortgage professional will work with you to make sure the refinancing will save you more than it costs. In fact, if your mortgage banker doesn’t help you do that, you need to find a different mortgage banker.
Now, to see how this all works, let’s look at a simple illustration. Suppose you owe $500,000 on a 30-year mortgage at a rate of 4 percent. With those terms, your monthly payment of principal and interest would be $2,387. If you refinanced that mortgage to 3 percent, your monthly mortgage payment would drop to $2,108, for a monthly savings of $279. If your non-recurring costs are $4,500, it will take just over 16 months to break even on the refinancing. As long as you stay in your house for more than 16 months, refinancing would make sense.
But suppose you only owe $100,000 on your mortgage. In that case, your monthly savings will only be $55 and it will take you 82 months, or almost 7 years, to cover the cost of refinancing. Refinancing might still make sense, but it is less compelling, especially if there is the possibility you will move within the next 7 years.
At the end of the day, the difference between 2.875% and 3.125% on your mortgage is not hugely significant. On a $100,000 mortgage, the difference in payment is a barely noticeable $15 per month. On a $500,000 mortgage balance, the difference is only $68 per month. For most people, in either case, saving that little bit extra is equivalent to a rounding error on your overall financial plan. You are much better off doing the refinancing if it makes sense and not worrying about trying to squeeze the very last drop out of the interest rate.
Steven C. Merrell is a partner at Monterey Private Wealth Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to email@example.com.