To Refinance, or to Not Refinance your Personal Residence Mortgage?
The mortgage interest rates are heading down, so you may want to consider refinancing your mortgage. There are a few factors to consider including your current employment situation, your credit score, the remaining years on your current mortgage, your current mortgage balance, and your current mortgage interest rate.
Factors to Consider in Refinance Decision
The decision to refinance your mortgage depends on your goals for taking the action, such as the following:
-Reduce total monthly payment.
-Reduce total interest paid over mortgage term.
-Reduce loan term to pay off mortgage balance.
-The closing costs for refinancing are less than the savings from the new payment over time.
-Your long-term employment prospects are positive.
Goal of Refinancing – Reduce Monthly Mortgage Payment
If your main goal is to reduce your monthly mortgage payment and you are not concerned about the number of years remaining on the mortgage term, or total interest you will pay on the loan, then refinancing for 30 years may be a good idea. However, in the long run this will cost you thousands of dollars in additional interest payments than you would make with a shorter loan term unless you make additional principal payments in the future to reduce the loan term. You would only take this approach if you cannot afford a larger mortgage payment now to reduce the loan term to 15 or 20 years, but you expect that your income will increase in the future and allow you to make extra principal payments. One issue is that the interest rate on a 30-year loan term is roughly one half of one percent higher than for 15-year loan term, so even with extra payments it will still cost more in the long run.
You may be able to deduct the mortgage interest, if your loan amount $750,000 or less and you can itemize deductions. However, you can only itemize deductions if such expenses as your mortgage interest, real estate taxes or state income taxes, medical expenses over the floor, and charitable deductions are more than the $24,800 standard deduction for a married filing joint couple in 2020. Another issue is that some of the benefit of the mortgage interest deduction has been reduced because of the limitations on how much mortgage interest you can deduct each year. You can only deduct mortgage interest for a loan with the principal amount up to $750,000, which at current interest rates for a 30-year loan term is $24,150 in 2020.
Goal of Refinancing – Reduce Total Mortgage Interest Paid and Loan Term
If your main goal is to reduce the total interest paid over time, then your strategy will go together with reducing the term of the loan from 30 years to 15 or 20 years. If you choose to refinance for a shorter loan term, then the total interest that you pay over the life of the loan will be significantly less for two reasons, the shorter number of months paying interest and the lower interest rate on a shorter term loan versus a 30-year mortgage. However, your monthly mortgage payment will increase, so you will want to ensure that you can afford to pay the higher amount comfortably considering your employment situation and other expenses.
The shorter term of the loan will save you tens of thousands of dollars in mortgage interest paid over the life of the loan for an average mortgage amount. For example, if the principal loan amount is $500,000, on a 30-year loan at the current average interest rate you would pay $283,337 in mortgage interest with a monthly payment of $2,176. However, on a 15-year loan at the current average interest rate you would only pay $110,759 in mortgage interest with a monthly payment of $3,395. In contrast after 15 years of a 30-year mortgage, the mortgage balance would be $310,000 instead of zero and mortgage interest paid by the 15-year mark of the loan would be $201,367, instead of $110,759. Therefore, it is a good idea that if you can comfortably handle a higher mortgage payment, then the 15-year loan is much better in the long run.
You can partially accomplish the goal of a reduced overall interest amount paid on your mortgage and reduced loan term by using the above-mentioned strategy of making extra payments when possible to principal. However, as mentioned above you would still be paying a higher interest rate on the principal which would partially offset the reduction in interest paid over time and the reduction in the loan term.
Refinancing Closing Costs
Another issue with refinancing is the closing costs of between 2% and 6%, depending on the size of the loan, which generally can be paid out of pocket with available cash funds, or added into the loan balance. You will generally want to pay the closing costs and any interest buy down (points) out of your cash because then you will not be paying interest on those costs over the loan term. A general rule of thumb is that it makes sense to refinance when the interest rate on the new loan is 1% lower than the interest rate on your current loan, even if the term of the loan goes back to 30 years. The result with this option is paying roughly the same total amount over the life of the loan as your previous 30-year mortgage. There are pitfalls to this approach because in the early years of paying off a 30-year mortgage a significant amount of the total payment is going toward interest versus principal. Therefore, if you were to sell the home a few years after the refinancing then you would lose a significant amount of money on the sale compared to if you had not refinanced. The lesson here is not to refinance, if there is a possibility that you will be selling the home within a few years because you will not recoup the closing costs with a lower mortgage payment and you will have a higher loan balance than if you had kept paying on the old mortgage.
Individual Circumstances Determine the Final Decision
Every homeowner’s situation is unique, so it would be a good idea to have a financial planner review your options with you. A mortgage broker will be happy to evaluate, if you should refinance your mortgage, but that does not always give you a complete picture because they are only focused on one aspect of your financial situation.
Lydford Financial, PLLC is offering a free refinance analysis through September 30, 2020, so email me, or fill out the website contact form to initiate the request. A preliminary meeting will be required to discuss your individual circumstances using Skype, Zoom, or in person, so reach out as soon as possible to receive this free analysis from Lydford Financial PLLC.