|Refinance keeping the existing term
Refinancing can be less appealing for many homeowners because the clock resets each time. In some circumstances, especially if you’re a few years away from paying off the home in full, a refinancing may not even make sense.
There are ways to refinance without starting the term over. The traditional 30-year fixed rate mortgage remains most favorable, so we’ll start there. Whether the purposes are strictly payment reduction, interest rate reduction or pulling cash out, the long-term does start over a new 360 months. With 30-year rates under 4.5 percent, opportunities to reduce payment by virtue of interest rate reduction are still abundant.
When starting over a new mortgage and the payment is reduced, the key is to make the same payment on the new mortgage you are presently making on the current loan you are paying off. Doing so allows you to benefit by reducing the interest, keeping the payoff time frame the same as the old loan, and the flexibility of paying a lower payment should your financial situation ever change.
Here are some example figures:
• Original loan amount taken out in January 2009 for $300,000 on a 30-year fixed rate mortgage at 5.5 percent with a current balance of $282,000 ¬– mortgage payment is $1703.37.
• New loan term of 30 years at 4.375 percent on same principle balance of $282,000 – mortgage payment is $1,407.98.
• Payment saving on 30-year mortgage is $296 per month
A smart mortgage shopper would stand to benefit by taking out the new 30- year mortgage one full percentage point lower in interest in exchange for the savings just shy of $300 per month. By making the $1,703 per month payment rather than the payment of $1,407.98 that’s actually due each month with the new loan, the loan would be paid off in 21.3 years versus the current 26 years remaining with the higher rate loan.
Loan terms that don’t start the term over
• 30-year loan: At loan application, it would be ideal to avoid pulling additional cash out. Mortgage tip – it’s going to require consistent diligence to be able to adhere to making an overpayment each month beyond the payment due. It’s easy to fall off the wagon, so perhaps a shorter-term, fixed-rate payment would be more suitable.
• 25-year loan: This is the next best option for homeowners looking to continue to chip away at that principal balance. It’s five years sooner on the payoff without making an extra principal payment.
• 20-year loan – The loan is paid off in 240 months, which is one year sooner than taking the 30-year term and making an extra principal prepayment. Again, expect a higher monthly payment without the ability to revert back to a lower payment should your financial situation ever change.
• 15-year loan – This provides the fastest payoff in exchange for a payment that is nearly double the new 30-year mortgage for an additional 15 years of being mortgage free.
It is important to be mindful of the fact that not all the rates on each of these programs are the same. In many cases, the shorter the debt structure the better the interest rate as well. For example, the 15-year mortgage is the standard for the lowest rates. Why is this? Because 15-year mortgages are much more attractive to the secondary mortgage market, as most mortgages are refinanced every five to seven years, if not sooner. A 15-year mortgage means the consumer is paying all the interest faster in a shorter period of time, making the loan more attractive to the end investor.
• Mortgage tip: For every rate quoted on a 30-year loan, expect one full percentage point lower in interest on a 15-year loan.
Making sure it’s not really a reset
• Make sure you can handle making the old payment on new refinanced 30-year loan.
• Keep the loan amount lower than your original principal balance (this would include increasing the loan amount unless you switch to a shorter term, such as a 20-year term or a 15-year term).
• Interest rate is the same or lower than current rate on loan being paid off.
• If mortgage insurance exists on the loan being paid off and the new loan contains a higher interest rate, the removal of the mortgage insurance alone greatly offsets even a slightly higher interest rate on the new refinance. The reason being that mortgage insurance (PMI) is usually anywhere from $200-$400 per month.
Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.