During the last several years homeowners have had more than one opportunity to refinance their home mortgage. Those who have purchased in recent years or refinanced within the last several years may believe they are in good shape.
The old adage that it is not worth refinancing unless there is a two percent savings currently does not apply. A two hundred thousand dollar mortgage at a rate of 5.5 percent should be refinanced today. While the new rate may only be 4.25 or 4.5 percent, this is a significant savings. A one percent drop in a 5.5 percent mortgage rate represents an 18 percent reduction. Back in the days when rates were around 10 percent, an 18 percent saving would represent a reduction of 1.8 percent, or about the two percent rule-of-thumb amount.
For every one percent reduction in the mortgage rate, a saving of approximately $60 will occur for every $100,000 financed. The actual savings is based upon the existing rate and the amount of the reduction, as such the amount saved each month will vary. But, someone with a $175,000 mortgage who can lower their rate by one percent, may save about $105 per month on their mortgage payment. While the savings may not seem very large, it will make a difference if handled properly.
Most individuals who refinance their home end the process with the new note payment. The savings winds up in the checking account as additional money to spend every month. While spending the savings may help with the current economic recovery, it may not be in your best interest. For those of you who refinance and keep the payoff date the same (replace a note with 26 years left with a new note for 26 years) but manage to reduce the payment because of the lower rate, the debt will be gone around the same date as before but now there is extra cash in the account each month. By investing the savings, a significant investment account can be created depending upon the number of years to pay on the note, and the amount of savings.
As an example, someone now able to invest$175 per month from the savings could create a portfolio worth $55,000 at the end of fifteen years. This is projecting a return of only 7 percent per year on the investment. If a 9 percent average return could be achieved, then the investment account would be approximately $66,200. Few homeowners realize the additional value they could create if the savings were invested rather than spent.
To refinance it will cost something. And while they say inflation is low, it seems like everything is costing more today. It may be confirmed that a savings of $210 per month will be created if the refinance takes place. However, it will cost $3,800 to accomplish. In this case, provided the homeowner will remain in the home at least 18 months, then the savings is worth the cost. ($3,800/$210 = 18.1 months)
With mortgage rates near their record lows, it is my opinion all mortgages should be refinanced if possible and to lock in the rates for as long a term as available. For owners who refinance but are not willing to invest the savings, it may be in their best interest to keep the payoff date the same. Thus, not refinance a note that will be paid off in 26 years with a new 30 year mortgage. Keeping the payoff date the same for this group will permit them to be out of debt at the same point in time, reduce their interest expense, and create extra cash each month for spending. However, those who have the discipline to invest the monthly savings and keep these funds invested over the years, this will increase their net worth due to the low cost of the mortgage and the expected higher return on their investment account. In fact, it may be worth paying a slightly higher rate for a new 30 year mortgage than a lower rate on a new 15 year mortgage. Again, this only holds true for those who are willing to invest the savings. Lengthening a mortgage debt just to have more money to spend does not make sense.
For assistance with this or insurance, estate planning and investment management contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. You can also view our learning center on our website, www.goqfc.com. There you will find articles on a variety of topics, on-line seminars, calculators, as well as a host of other free tools.