What are the benefits of re-financing my loan?
September 30, 2012 2:34 PM   Subscribe

Homeowner needs advice: Bought a house one year ago, loan rates at all-time low, what are the benefits of re-financing my loan? Any disadvantages? I'm clueless...

The web is chalk full of articles on re-financing that seem like used car salesmen trying to sell me something that has hidden agendas. Point me to solid research and evidence that it wouldn't be a mistake to re-finance. What are the upsides, especially considering I'm only a year into my loan. I'm currently sitting at 4.5% on a 30-year loan. Any advice would be appreciated deeply.
posted by MMALR to Work & Money (13 answers total) 6 users marked this as a favorite
What are the upsides, especially considering I'm only a year into my loan.

The upside is that if you can refinance for enough lower rate to make up for the transaction costs (eg origination fee, etc), you will save big time over time. Do the math and see what your total cost over time would be if you dropped from 4.5 to 3.5 percent, or whatever the best rate you can get is.

I refinanced twice as rates dropped (and also shortened the length of my loan, another way to save money over time). But whether or not this makes sense in your position means looking at specifics, not generalities -- how much you owe, your credit score, etc.
posted by Forktine at 2:52 PM on September 30, 2012

Interest on a mortgage is front-loaded -- in other words, out of $500, maybe $20 of that is principal, maybe $100 is taxes, and the rest is interest. On your last payment, that will be reversed: $20 will be interest and most of the rest will be principal.

That means you stand to benefit a lot if you can get a better rate now. I did that when I owned a house in my twenties. It lowered my monthly house payment a meaningful amount. If you don't really need a few extra bucks for current cash flow, you can keep paying the same and get even bigger savings by paying it off sooner.
posted by Michele in California at 2:53 PM on September 30, 2012

Refinancing amounts to a simple calculation, and then deciding based on whichever of two details matters more to you.

First, plug your numbers into an amortization calculator (technically the "payment schedule" of that link, but you don't really need the whole thing, it shows you the two numbers you want right on the main form).

Two of those numbers matter to you - The "Periodic payment", and the "total interest".

If you prefer to maximize short-term liquidity, you want a smaller periodic (aka "monthly", in most cases) payment. If you prefer to maximize long-term wealth, you want the smallest total interest.

Most people will want to find some compromise between the two - The ideal total interest would come out to zero if you could pay cash up front, and the ideal monthly payment would have you paying nothing but interest, forever (or more practically, you could just rent). As a rule of thumb, you want to shoot for a monthly payment that eats 30% percent of your monthly income.

That said, run the numbers on a few different types of mortgage that you might not seriously consider otherwise - For example, if you had a 30 year at 5% and can now get a 20 year at 3% (a realistic number in the current market), you'd pay less than 10% more per month but pay less than a third of the total interest.

Basically just run the numbers, then consider the inconvenience factor. If you'll only save $5k in the next 20 years, probably not worth bothering. If you'll save $50k, practically a no-brainer.
posted by pla at 2:53 PM on September 30, 2012 [1 favorite]

A word of warning about all of these mortgage calculators I see around the internet - they always seem to assume that inflation is 0%. Which is never the case. Just a small caution.
posted by Yowser at 3:00 PM on September 30, 2012

What I mean to say, is that these mortgage calculators don't tell you how much you'll be paying in TODAY'S dollars because they make the fundamentally erroneous assumption that inflation is 0%.
posted by Yowser at 3:01 PM on September 30, 2012 [1 favorite]

Also, forgot to mention... it is a FHA loan. Looks like everything is around 2-3% which is obviously what I would like, but I haven't got much room since I've only been paying for one year. Seems like I might be able to get 3.25 or 3.5%, which still saves me 20k-30k in interest along with about $80-100 a month possibly.
posted by MMALR at 3:18 PM on September 30, 2012

The biggest problem I had was finding a lender to do the refi with so little equity in the house. We only found one bank who would talk to us. It only takes one. We went with it. It had all kinds of financial benefits for us.
posted by Michele in California at 3:22 PM on September 30, 2012

which still saves me 20k-30k in interest

That's a best-case scenario that assumes you'll stay there for the full term of the loan. It's important to consider the other extreme, i.e. what if you get a great and faraway job offer in 3 years and decide to move. In the short term, closing costs are likely to eat all the interest savings.
posted by jon1270 at 3:26 PM on September 30, 2012

@jon1270 That is definitely something I need to think about. We may end up moving into a bigger home in five years, possibly into a better school district, so that is something else to think about.
posted by MMALR at 3:27 PM on September 30, 2012

Also, forgot to mention... it is a FHA loan.

Danger, Will Robinson!

Do you have 20% equity yet?

If not, refinancing can cost you a LOT more - You won't get as good rates, you need to factor in the cost of PMI, and the bank will play it a lot more picky about the million and one appraisals and inspections they can require (think $3-4k in closing costs rather than $700 that mostly goes to a single appraiser).

(on preview, what Michele said - But good luck finding that one!)

Still worth at least looking, though - Good luck!
posted by pla at 3:27 PM on September 30, 2012

FHA loans can be good. You can get a streamline refi without having your house appraised. The only downside is the rates tend to be a bit higher for an FHA loan.
posted by zephyr_words at 3:43 PM on September 30, 2012 [1 favorite]

Fwiw: We moved less than two years after the refi. In a depressed market. Selling would have lost us our shirts (and some skin, I think -- with or without the refi). The refi helped position us to rent it out and hold on until prices went back up.

I can memail you the longer, more detailed version if you are interested.
posted by Michele in California at 4:24 PM on September 30, 2012

My wife and I bought (well, built) our house two years ago, with a 4.8% interest rate. We're closing on a refinance tomorrow morning, at 3.5%.

The basic math is the payback period on the cost of the refinance. Let's say that your refinance will save you $100/month on the mortgage. And the closing will cost you $2,000. That's a 20-month payback period. Some mortgage brokers and banks set a cutoff of 18 or 24 months—anything more than that, they're just not interested in. (Others don't care.) Perhaps more important is whether you're going to be living in the house for longer than the payback period. Yes? Great, then refinancing is probably a good idea. No? Then refinancing is probably not a good idea.

Our payback period is 16 months, and we intend to live here for the rest of our lives, so it definitely makes sense for us. :)
posted by waldo at 6:10 PM on September 30, 2012 [1 favorite]

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