With some sense of normalcy starting to creep back into our world, we are going to visit some of the reasons why there is a compelling argument to justify refinancing your mortgage. Let us start with some of the facts that we know. First, mortgage interest rates are near historic lows. In addition, we have seen that homes have surprisingly held their value through the recent economic turbulence we faced the last few months. To add to the good news, we have seen stock market values increase well above the lows that we experienced in March. As banks and other lenders have tightened their lending policies, the recent economic positives have created opportunity that may have not been an option for homeowners a few months ago.
As communities begin to reopen, we are seeing individuals return to work and local economies start to rebuild. This is the most positive news that many of us have received in quite some time. However, as the economy recovers, we can expect interest rates to react as well. When the Federal Reserve lowered interest rates at a historic pace in March, they did so with a message that the drop was temporary. They warned that they would attempt to raise rates with the improvement of the economy. While we all want to see our friends, family and neighbors return to work it does bear noting that this may lead to a rise in interest rates.
However, none of us know if this trend will last and while we are not here to speculate if the recession is over, or if the virus will have a second wave this fall, we do need to acknowledge that these are possibilities. Therefore, now may be a prime opportunity to revisit refinancing your mortgage and increase your financial stability. By taking advantage of the current economic environment you can prepare for the unknowns. As the old saying goes, “The best time to prepare for rain is when it is sunny”. Taking advantage of the current low interest rates, homeowners have the ability to save money by either keeping a similar monthly payment and reducing the term of their loan; or reducing their current monthly payment and keeping the term of their loan the same. Either option may be a good opportunity to save you money in the long run. The examples below will help you understand some of the pros and cons of both.
Let us look at a case study to help illustrate either of these options.
You bought a house exactly 5 years ago for $300,000 and the terms of your loan were a 4.5% for 30 years. (To keep things simple, we will ignore taxes and insurance, and assume there was no down payment).
Your original loan would have looked like this:
- Mortgage Amount: $300,000
- Interest Rate: 4.5%
- Mortgage Length: 30 Years
- Monthly Payment: $1,520
- Total Cost of Mortgage: $547,220
- After making five years of payments, your new principal balance would be $273,474.
Option One: Keep your monthly payment the same but lower the term of your loan.
By taking advantage of the low interest rates to shorten the term of your loan you’re going to save yourself potentially thousands of dollars in interest payments that would’ve otherwise gone to the lender. Also, the idea of paying off your mortgage a few years sooner is exciting for any homeowner.
- Your new loan would look like this:
- Mortgage Amount: $273,474
- Interest Rate: 3.25%
- Mortgage Length: 20 Years
- Monthly Payment: $1,551
- Total Cost of Mortgage: $463,472 ($372,272 + $91,200 from the original loan)
By taking advantage of the lower interest rates you would be able to reduce your overall mortgage length by five years. Your payment would slightly go up by $31/month, but that small change would allow you to save over $83,000 over the life of the loan.
Option Two: Keep your term the same but lower your monthly mortgage payment.
By using the lower rates to simply lower your monthly payment, you now have improved your cash flow which could allow you to spend your dollars another way. In addition to the monthly savings, you will also save money over the life of the loan in this example.
Your new loan would look like this:
- Mortgage Amount: $273,474
- Interest Rate: 3.25%
- Mortgage Length: 25 Years
- Monthly Payment: $1,333
- Total Cost of Mortgage: $491,005 ($399,805 + $91,200 from the original loan)
Here you can see that while you are still paying the loan for the original 25 remaining years, you have lowered your monthly payment by almost $200 and saved yourself over $56,000 on the life of the loan.
While the numbers clearly show how these both could be great options, we are going to make a special case for why the better choice may be Option Two. By lowering your monthly payment, you are making a direct and immediate impact on your cash flow. This will allow you to improve your overall financial stability in a much quicker fashion. Leveraging the ‘extra’ money in your budget created by refinancing your mortgage will provide you the opportunity to pay down other debt, create an emergency fund or save additional dollars into your retirement accounts. Also, you still could pay more towards the principal on a monthly basis once you shore up your other financial priorities. The idea is to give yourself a larger cushion in the event something does not go according to plan.
A word of caution – this plan only works if you avoid lifestyle creep. If you do not have the self-control to put those ‘extra’ dollars to work for you, you may find yourself in a worse position than you were prior to making the refinance. Moral of the story; put your money to work for you, not Amazon or Starbucks.
With uncertainty still looming, now is the time to take hold of your financial picture. Take advantage of the recent opportunities created to rebuild your financial foothold. We encourage you to take a hard look at all of your financials to see if you can find room for improvement.