When mortgage rates are low, should you refinance? Part 2: Additional Considerations
In my last piece , I covered three key factors to help you decide whether and how to refinance your mortgage to a lower rate. Today, we’ll cover three more.
Private Mortgage Insurance (PMI): If your home’s loan-to-value (LTV) exceeds 80%, you must pay for PMI, to protect the lender (not you!) against default. For example, if your home is worth $400,000 you can avoid paying PMI by borrowing no more than $320,000 (80%) on a first mortgage. If you do incur PMI payments, you can eliminate them once you’ve paid enough principal, or your home value has increased enough, or more likely both, to drop your LTV to 78% or less.
Mortgage terms: How long should you borrow for? The most common terms are 15 or 30 years, but you can also find 10- and 20-year loans, or usually choose to pay off a loan earlier than its term.
Normally, the shorter the term, the higher your monthly payments, but the lower the rate (since there’s less risk to the lender). This suggests taking the shortest loan you can afford to pay on every month. But there’s a caveat: Even if you can afford higher payments, you may still want to go with a longer term and lower monthly payment … IF you have the discipline to invest the difference and earn a higher return than the mortgage rate.
For example, say you can save $1,000 on each monthly payments by taking a 30-year mortgage at 3.5% vs. a 15-year mortgage at 3.0%. You can come out ahead (and maybe use the proceeds to pay off your loan faster) if you can invest that $1,000 at, say, 5.0%.
Rolling fees and escrow: Mortgage lenders usually “roll” all your refinancing fees and escrow payments into your new mortgage (including real estate taxes and homeowners insurance) and, thus, increase your new loan amount. But they don’t have to. For example, if you can afford to pay the refinancing fees out of pocket, you can reduce the balance on your new mortgage, and thus the interest paid.
That’s a lot to consider, so we’ll stop for now and cover the rest in Part 3. Or, if you’d rather not wait, visit alliantwealth.com/resources/whitepapers.html to read our full report now.
John A. Frisch, CPA/PFS, CFP®, AIF®, PPC™ founded Alliant Wealth Advisors in 1995 and has over 30 years of experience as a financial professional. In his free time, he’s an avid long-distance runner, a sport that requires discipline, patience and vision. John applies these same skills to his professional pursuits: He helps families and retirement plan sponsors adopt a patient, disciplined approach to overcoming financial challenges and reaching their distant goals along a clear path. Learn more at www.alliantwealth.com.