How to Actually Know if Your Mortgage Refinance Makes Financial Sense

July 8, 2020
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When looking at the current real estate and mortgage refinance markets, two financial indicators really stand out:

  1. Mortgage rates are at historic lows
  2. Home prices are on the rise

Understanding These Indicators

Both of these are fairly easy to explain. First, mortgage rates have already been very low in the past few years. Then, the economic impact of COVID-19 forced them to go even lower as the country tries to recover financially by sparking more consumer activity.

Home prices, like every other commodity, are driven by supply and demand. Even before coronavirus, housing inventory has been low in recent years. This has made it a seller’s market because they essentially hold all the cards when there aren’t as many properties listed for sale. This—when combined with low mortgage rates that allow buyers to afford more—drives home values upward. Right now, many people are eager to move during this condensed summer market. The demand outweighs the supply, and home prices will likely keep increasing for the foreseeable future.

Is it Time for a Mortgage Refinance?

These conditions make it ideal for other homeowners to refinance their mortgage loans. Instead of selling, it might make a lot more financial sense to stay put and take advantage of what’s happening in the mortgage market. Higher home prices mean more equity, and thus more borrowing leverage. Lower interest rates mean better loan terms and lower monthly payments. It would seem like a no-brainer to refinance, right?

Well, as with any major financial decision, the answer isn’t always so simple. Despite the current market conditions, refinancing may still not be the best option for some homeowners. In fact, many homeowners may not even qualify for a refinance under today’s tightened lending standards.

Qualification Standards

Lenders are being flooded with borrower applications (both new home loans and especially refinances). This means they can afford to be picky about who they approve and what loan terms are given. Because of the country’s overall economic situation, lenders and banks are out to take as little risk as possible. Borrowers with low credit scores or weak financial standing will find it harder to get a mortgage loan. Even if they do qualify, the lowest interest rates are reserved for those who are considered “top-tier” candidates by the underwriters.

This is not to say you shouldn’t explore your home refinancing options. You may qualify for a better loan with lower rates, and that can save you a lot of money over the length of the mortgage. My point is that banks are not handing out free money to homeowners right now—they never are—so you have to go into the process with realistic expectations.

Do Your Research

No matter when you consider refinancing, you always have to research if it’s the right move or not. Even when you qualify for a lower rate or condensed loan time frame (say going from a 30-year fixed loan down to a 15-year term), you may not be gaining that much. There are closing costs, loan length, monthly payments, front-loaded interest payments and other factors that need to be figured into your decision.

In a basic sense, the total sum of the costs associated with a refinance (calculated from now until the mortgage is fully paid off) should be less than the total costs of the old mortgage from now until it is paid off. If it is not, then the refinance really doesn’t make sense. Even if there are slight net gains with a refinance, you have to weigh all the options and information.

For example, let’s say you currently have a 3.75% interest rate and you are 5 years into a 30-year fixed mortgage loan. Your refinance gets you down to a 3.25% rate and will lower your monthly payments by $200, but you are essentially restarting the 30-year loan period and tacking on five more years of mortgage and interest payments. Your monthly payments will go down, but your net gain may not be worth the trouble. You might even be paying more in the long run.

Consider the Time Frames

You also have to look at the length of the loan with a refinance situation. You might be able to get an even lower rate on a 15-year loan. Your monthly payments may go up compared to what you are paying on your current 30-year loan, but you are paying off the mortgage sooner and saving much more money over the length of the loan.

Another factor you have to look at is how long you plan to stay in the home. If you are expecting to be there until the mortgage is fully paid and beyond, then refinancing to lower rates or shorter loan periods often makes sense. However, if you are planning on moving in 5-10 years (long before your loan is paid off), you have to calculate the “break-even period.” This is the period over which the costs of the old loan and the new loan are equal.

If you expect to be in the home beyond the calculated break-even period, then a refinance will likely be beneficial. If you are planning to move sooner, then you may be doing a disservice to yourself by refinancing now. Remember that all mortgage loans are front-loaded with higher interest payments during the earliest years. Every refinance is essentially a restart, and you may not end up paying down much more of your loan principal if you move soon after you refinance. This lowers your ultimate equity and decreases your overall return on investment (ROI).

Exploring Your Mortgage Refinance Options

With interest rates being so low and home prices on the rise, it’s worth looking into a refinance right now if you are in good financial standing. Just be careful to weigh all your options and run the numbers to be sure that it’s a smart financial decision. You could be saving a lot of money over time, you could just be breaking even at best or you could end up wasting your time (and your money) if the new loan really isn’t improving your situation as long as you plan to live in the home.

If you are considering refinancing your home and need help making the right financial decisions—whether in real estate, business ownership, investment management or retirement planning—Illumination Wealth is here to help. Contact us today to schedule a free initial consultation with one of our top financial advisors.