We’re facing a lot of challenging news these days, but one silver lining is the steady decline of home mortgage interest rates. Although they aren’t likely to drop to zero in line with the federal funds rate, there are several compelling reasons to consider refinancing now.

Financial considerations before you refinance your mortgage

First, look at the elements that should shape your decision:

• How long do you plan on owning your home?
• Do you want to take some cash out of the value of your home as part of the refinancing?
• Which do you want to reduce, your monthly payment or the life of the loan?

 

The different types of mortgages and financing options

As you probably know, there several varieties of mortgages. What’s referred to as a “conventional” mortgage in the U.S. is one not offered or secured by a government entity. It could be obtained from a private lender or one of the government-sponsored entities (GSEs), Fannie Mae or Freddie Mac. Larger conventional mortgages can be issued as “jumbo” loans that exceed the “conforming limit” set each year by the Federal Housing Finance Administration (FHFA) on a county basis across the country. This year, the “non-conforming” loan limit ranges from $510,400 – $765,600.

Other types of loans can be underwritten with less documentation of financial status from the borrower, if you qualify. To determine the size of loan or interest rate a lender feels comfortable offering, it will analyze your assets and liabilities to make sure you can make your monthly mortgage payments, property taxes and homeowners’ insurance, which usually shouldn’t exceed about 30% of your gross income.

Other financing options include fixed-rate loans — the most common types are set at an unchanged monthly payment for 15 or 30 years:

• Adjustable-rate mortgage (ARM) – The interest rate adjusts to a pre-determined index after an initial teaser period, and this initial rate usually lasts for a few years.
• Interest-only mortgage – This type of mortgage allows the borrower to pay only the interest amount for several years, creating a lower monthly payment. This choice might work well for someone not planning to own a home for long, but the downside is that the sizable principal amount is due either in a lump sum at a later date, or in subsequent payments.

 

How to determine if refinancing makes sense

You’ll want to comparison-shop to be sure the interest rate offered by the lender you pick serves your needs, as outlined in the list above. Usually refinancing homeowners are seeking either a lower monthly payment or a shorter time until the loan is paid off. Once you define your goal, the lender will come up with an interest rate that reflects the amount being borrowed, your overall creditworthiness and the lender’s profit margin. Keep in mind that when you refinance, even if the interest rate is lower, you may end up paying significantly more interest over the life of the loan because the maturity of the loan might be being extended.

Don’t overlook closing costs, either. Even if a lender’s offer of a lower rate sounds enticing, no refinanced mortgage comes without expenses that get rolled into the amount you must pay back over time. For example, points, both for origination to compensate the lender and discount points (which are a form of prepaid interest), could be tacked on. A point is equal to 1% of the borrowed amount. Beyond that, a possible appraisal fee to determine your property’s current value, title insurance and state and local recording fees could be included and, in total, amount to thousands of dollars above the interest charge. Ask lenders you interview about these fees to make sure the effort and cost of refinancing is worth it for you.

Lastly, it’s important to consider the advantages of paying the closing cost upfront or capitalizing them, adding it to the loan balance. Some of these expenses can be deductible on your tax return. Others may be treated as additional money spent on refinancing your current loan balance when it comes time to calculate the gain on a later sale of the same property. Further, remember that your monthly payment might include escrow (homeowner’s insurance and real estate taxes that both can rise steadily every year in some locales), so the final adjusted monthly payment in that case will be larger than the new amount owed each month to the mortgage lender.

Working with a financial advisor can help you determine if mortgage refinancing makes sense for your holistic financial plan. Have questions? Contact your Altfest wealth management team or schedule a complimentary consultation at this link.

 

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Steven Novack, CPA, CFP®, MBA, works with clients and their families to develop and execute financial plans designed to achieve their personal and financial goals. Steven is a graduate of The George Washington University and New York University. 

 

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