This may seem like an article from the left field, but with all the recent market turmoil, it’s hard not to be interested in the economy. I wrote this some time ago for my own reference, and here I share it with everyone.
I was looking into refinancing my house if the interest rate drops any lower. I’m currently at 5.375% on a 30 years fixed rate, which is pretty low. If you can go 1% lower, you can save 1,500 per year on a $150,000 loan.
What affects the 15/30 year fixed interest rates isn’t the Federal Reserves lowering interest rates. It is not directly tied, but influenced by it. What directly drives the long term fixed rate is supply and demand — people who want to buy long term bonds because people are scared of risk. A lot of people demanding long term bonds means increase in demand, so the interest rate goes down for these products.
The difference between a 15 and 30 years mortgage is that a 15 years mortgage will typical have around 0.5% lower interest than a 30 year mortgage. Of course, this means that you will have a higher monthly payment as well. But that does not mean that you can’t pay off your 30 years mortgage in 15 years by paying more than your minimum monthly payment. It’s just that the minimum required payment per month is lower.
If you are saving 15-20% of your income into a retirement account, then you are a good candidate for a 15 years mortgage. Another thing to consider is the alternative minimum tax. If you are a married couple making 140-150 per year, or single and making 70-90 per year, the alternative minimum tax kicks in (if you have too many deductions). If you hit this area, they start wiping out your deductions. If you’re not getting the tax benefits, then it might be a good idea to pay off the house sooner.
When you refinance, lenders will offer you the option of paying for a discount. Meaning, they will agree to lower your interest rate if you pay a certain dollar amount up front. Before considering whether it’s worth it, do a break even analysis.
For example, if you have a $200,000 loan and a 30 years fixed loan, and the lender offers you 5.5% interest rate, then that will be $1136 per month payment. If they offer you 5.25% if you pay $1500 at closing cost, then the monthly payment drops to $1104 per month, which is a $32 per month in saving. It will take you 47 months (1500/32) to make up that $1500. So if you know you’ll be living in your house for at least that long, then it’s a good deal.
There are also two types of no-cost refinances. One of them is the fake type, and the other the real one.
The fake ones roll the closing cost into the loan balance. This is not really free because you’ll be paying for it over the life span of your loan. Meaning if your closing cost is $5000, you’ll be paying for it for 30 years, meaning that $5000 can turn into $10,000 to $15000. So stay away from these.
The real ones will usually have a premium on the interest. Typically the interest rate on these will be 0.5% higher. But you do not pay the closing cost. However, there are some fees that you cannot get away from no matter what, such as the prepay items like taxes, reserves, homeowners insurance etc. However, if you’re current on a 6.5% interest and you can refinance to 6%, then you saved 0.5% at no cost to you.
Another thing to consider is escrow. Lenders generally like you to have escrow and might even charge you a premium if you decide to pay your own taxes. But if you have good credit and are responsible about your finances, you’ll probably want to pay it separately and leave that money in an interest earning account and pay the escrow when the tax is due.
It’s a good idea to educate yourself about what’s involved in the closing cost. Some fees can be negotiated, and others can’t. You cannot negotiate 3rd party fees such as title search, appraisal, attorney fees, etc. However you can negotiate fees such as courier fee, express mail fee, administrate fee. There are also garbage or junk fees such as excessive processing fees, documentation fees, underwriting fees, application fees — these you really want to try to avoid.
And request that they provide you with a good faith estimate, and the day before closing, ask for a HUD statement which will show you exactly how much money you need to show up at the closing table so that you are not surprised.