Mortgage rates are still setting record lows! Qualification is still very difficult to refinance for those with little home equity, but there’s still many people out there that are eligible (maximize your appraisal). Don’t miss your opportunity to lower your interest costs and own your home faster by believing in one of these common mortgage refinance myths:
#1 I don’t want to pay the high closing costs again.
It’s true, when you refinance there will be additional costs. The mortgage broker has to eat! However, that doesn’t mean you actually need to pay anything extra.
First of all, you can get paid for negative points. Depending on the interest rate, the originator/lender will actually pay you a credit each 1 point = 1% of the loan principal. The lower the rate, the less points you’ll get. But if the credit is high enough, that may cover all your costs, making it a “no-cost” refi. Alternatively, they may simply advertise “no closing costs” which means they cover a certain list of fees.
When you apply for a refi, you’ll get a Good Faith Estimate (GFE) with a total closing costs amount listed at the bottom. However, you should separate the true costs from the stuff that you’d otherwise have to pay anyway, including:
- Prepaid or partial month interest
- Homeowner’s insurance to escrow
- Property Taxes to escrow
The remaining amount (origination fees, doc fees, application fees, appraisal fees, title insurance, credit report fees, etc.) is what I would just call the true cost of refinancing. Some “no closing cost” lenders still make you pay the title insurance fee.
#2. I can’t refinance because it’s been too soon since my last financing.
There are no federal laws or mortgage contracts that prevent you from refinancing again (but check your state laws, thanks Peter!). In fact, it’s quite expected by investors that borrowers will refinance when rates drop. In fact, if you have a Freddie Mac, Fannie Mai, or FHA loan, you may be able to get your appraisal waived if you are refinancing within a certain period of your last appraisal.
However, some loans do have prepayment penalties that can come into effect if you pay off additional loan principal within an initial time period. Usually these loans offered extra-low interest rates or are forced onto subprime applicants. In general, prime mortgages do not have prepayment penalties, although you should read your contract carefully to make sure. If you do accept a prepayment penalty, make sure you’re getting something worthwhile in exchange. I would rather avoid them completely as it makes it easier to compare different loan options.
#3 I already refinanced recently and I haven’t reached my breakeven time period yet.
This is based on the concept of the “break-even” period. For example, if a refi cost you $2,400 in net closing costs but saved you $100 per month, you’d break-even in 24 months. Past that, you’re saving $100 every month. But what if after only 10 months, rates have dropped even lower so that you can again refinance to a lower rate?
This is a variation of the sunk cost fallacy. You’ve already spent the money and you can’t get it back, so it’s too late to worry about it. You can only do what’s financial best starting from today, and if you can lower your interest rate again with an acceptable new break-even period, then you should do it.
The simple way to avoid such mental gymnastics going forward is to see if you can get a “no-cost” refi. As long as you can lower your interest rate without having to put up more money (keeping in mind the unavoidable costs listed above), then you know you’ll come out ahead. This may not get you the absolute best rate, but when comparing mortgage quotes, it makes life easier when you just look for the lowest rate that will be no cost to you.
#4 When you refinance, you’re either losing equity or not building equity as fast.
First, as long as you’re not performing a cash-out refi that adds your loan principal, you won’t lose any equity with a refinance. All your previous payments and any additional principal prepayments you sent in will reflected in a smaller loan principal (the amount still owed).
The second part about “building equity” seems to be based on a misconception on how amortization works. Your mortgage payment is always split into a portion that pays down your principal and another portion that goes toward interest. If you have a $200,000 loan at a 5% interest rate, $10,000 will go towards interest that first year no matter what kind of mortgage you have. Going forward, your annual interest payments will always be close to your principal left times interest rate, be it 10-year or 30-years long. The rest goes to principal.
So let’s say you had a 30-year mortgage with $200,000 initial loan amount at 5% interest ($1,074 monthly payment) that you want to no-cost refi to 4.25% interest ($984 monthly), but you’re already 2 years into the mortgage. Uh-oh! Instead of 28 years left, you now have 30 years left again. No no no! Assuming no prepayment penalty, you can always send in additional principal payments so that you build equity just as fast or faster than before. I do it automatically every month via direct ACH withdrawal from my checking account.
As long as you pay the same monthly amount as before ($1,074), you would actually be done in a little less than 26 years. That refi would allow you the option of paying off your house 2 full years earlier with zero change to your current payment! I like looking at things this way as opposed to a monthly savings of $90 a month.
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Nice post.
Not to be picky, but this statement: “If you have a $200,000 loan at a 5% interest rate, $10,000 will go towards interest every year no matter what kind of mortgage you have, be it 10-year or 30-years long. ” is not exactly true.
That’s true at the beginning, regardless of the term of the loan. Each month you pay down some principal (that’s the amortization) and as a result the remaining balance of your principal outstanding goes down, so the 5% interest you are paying on that reduced balance is lower and you pay more principal each month than the month prior. In the very first month of a 5% $200k mortgage you would pay the exact same amount of interest on a 10-year as a 30-year loan (1/12*5%*$200k), but after the first payment the remaining principal balance of the 10-year loan would be lower than the 30-year loan (because the monthly payment on a 10-year loan is higher). So in the second month you’d actually be paying less interest on the 10-year mortgage than the 30 because the loan balance is lower after that first higher payment.
That’s how the 10-year loan gets extinguished so much faster, without the payment being 3x the payment on the 30-year mortgage. It’s the magic of compounding in reverse.
Thanks for your work, I’ve been following your blog for a while. There is certainly no law in the national level that prevents people from re-financing again, but in Texas, laws prevent consumers to re-finance within 1 year of the last re-finance, just past my exam not long ago.
This is an interesting post indeed, particularly #3.
I refinanced only a few months ago from being 2 yrs into a 30 yr loan @4.875% to a new 30-yr @ 3.875%. All fees (title ins., etc) added up to approx. $2000 So now 4 months later, I’m finding it very hard to swallow refinancning again to 3.5% since I’m not even close to the break even point.
If I’m reading this post corrrectly, the decision should only come down to the NEW break even point, which would be far longer in my case since my rate is only 0.375% lower. Therefore, I should be comparing the new breakeven point to the expected time from now that I expect to stay in this home?
Andy – that is not being picky, it is being correct. I like the post also but caught that same error. It’s actually important because so many people misunderstand mortgage calculations. The fact is that on a $200k mortgage at 5.0%apr you will never actually pay $10k in interest in a year, let alone every year (unless you miss payments).
Thanks for sharing some myths (and some solutions). I’m hoping to refinance later this year.
Yup, I was wrong about the “every” year part, I meant that you’ll be paying average principal owed * interest rate every year. As long as the interest rate is lower than previously, you will be paying less interest and thus if you payment is equal to before, more will be going towards principal. Hope that clears things up!
On a $200,000 mortgage at 5% interest over a 30-year amortization, your annual interest payments on the first year will total $9,933, very nearly $10,000. It’s a bit less because you are paying some towards principal (~$3k over the whole year) and thus your average principal owed goes a little under 200k.
@Peter – Thanks for the comment, I was not aware of that. I updated the post.
@Steve – Your decision today should only factor in your new breakeven point, but that doesn’t mean you should necessarily accept another long breakeven period. Your decision today should still take into account that rates may drop lower, or that you may be able to get better terms shortly in the future. Just don’t give up a refi because of past spent money.
It can be a tough decision given these record low rates, but that’s exactly what I was telling myself a couple years ago about “record low rates”. 🙂
Just had a great experience with refinancing and wanted to share a couple of lessons learned (or relearned) for me. Everything I’d heard about credit unions being much better to deal with than big banks turned out to be true. I went to Bank of America first, since they held my old first mortgage and HELOC, but they didn’t seem especially interested in keeping my business. My credit union gave me a wonderful package to refinance both loans into a jumbo that will save me about $1300 a month, with very low closing costs. Plus they were professional and a pleasure to deal with. And some people may not know that they don’t have to go with the mortgage company’s recommended title insurance and settlement agent. I shopped around and got a great price from AMC Settlement which cut those costs in half and, since they did my last refinance, did the title search at a much lower “reissue” rate. Only regret? Wish I’d done it sooner.
Just started the refinance process with Wells Fargo(they are our current mortgage holder). They have a program called the Wells Fargo Three-Step Refinance SYSTEM. They locked us into a 30-year 3.50% no closing cost refinance with a 30-day close. I’ll let you know how the process goes. Sounds pretty painless.
If you already have a short term (say 15 years) I would think before refinancing for another 15 year term you would want to know how much interest you will end up paying over the life of the loan. This compared with total interest for the current loan would weigh into the decision about refinancing. I realize you can invest the savings but then you would have to make assumptions about how much you could earn on the savings and so forth. (Ok and I guess you need to take into consideration tax benefits on mortgage interest). Refinancing is a bit of hassle (have done it twice in the past 7 years) so I’d want to be sure it was worth the effort. Thanks! Charles.
10 year treasuries are now lower than 1.5% (down from around 2% earlier this year). Rates will likely go down further.
Is anyone aware of a no cost or low cost refinancing option in New York? I refinanced once at 4.5 but closing costs were 5k. Would like to avoid that again if possible.
Update of refi: I just did my 3rd refi (out of total of 8 in last 3 years, all were no points, min cost < $200) with Provident funding for super confirm loan of 625K 30 year FRM @3.75 and 0 points and a closing discount of -0.75% points.
Raghu
raghu – OMG! How? Are you taking out more than you owe currently to cover the closing costs?
We’re in a refi (4% @30 years jumbo conforming) and opted to add 4k to the loan so we could end up with a net cost of $0 on the refi. Additionally, the monthly savings will be $650 a month so even if we paid a hair more we were looking at saving almost $8k a year on our mortgage.
@brkf
No the -.75 ($4700) points will cover closing cost of $2800. The rest they put in escrow which I can pay my home insurance or close the escrow after couple of months
Raghu
I’m in the process of a refi now. Going from 3.875% 15 year (financed about a year ago) to 2.875% 10 year. Will save us about $45,000 in interest even after factoring in the closing costs.
Wow! Great article on refinance and love the comments made regarding real refi’s happening. Please continue to update so we know the outcome. Thanks!
Update-We received our Close at Home mortgage kit(Wells Fargo) on the 13th. They had it back by the 18th. Loan was approved that same same and our old mortgage will be paid off this Friday, the 29th. No appraisal, no income verification, no cost, no hassle. One of the most painless financial transactions I’ve ever gone through. And if we open up a checking account with direct deposit to pay our mortgage, they’ll give us $150.
I just refinanced my home. My home is 5 years old and I have lived here for the 5 years. I was told that Obama’s bill stated we should not have to pay an appraisal fee to refinance. Is this true?
Very nice blog! I’m a very strong believer in mortgage refinancing as well and when I hear people
saying bad things about mortgage refinancing I know they don’t know what they are talking about. Especially when they talk about the penalty being too high without factoring in the total net savings a client will have depending on the amount of high interest debts the consumer is consolidating. Very very nice post!! I couldn’t agree more!!!
If anyone entered into a 3-step Refinance Loan with Wells Fargo within the past three years, I would like to speak with you. I’m an attorney and have discovered some interesting facts about the Wells Fargo program that may have not been disclosed. I can be contacted at rsn@randallnewman.net