I recently got a question from a subscriber about whether she should refinance her mortgage. With interest rates at historical lows and mortgage rates hitting their lowest level in years she and her husband wanted to take advantage of the situation.
She sent me basic information about her existing loan, including the amount, term and interest rate, as well as the terms of other loans they were considering. Their key question centered around whether to refinance their existing higher rate 30-year mortgage into a lower rate 15-year loan. The 15-year loan would have a lower interest rate, but would increase their monthly payments by a few hundred dollars because they would need to make higher principal payments. The end result of getting a 15-year loan would be that they could be mortgage-free in 15 years. She was curious about what she should do.
At the FinancialVerse we are not in the financial advice business, which would require us to be licensed to conduct this business. What we could do was provide her with some thoughts on what she and her husband should consider as they made this decision.
Here are some ideas and questions that I gave them:
The decision to refinance your mortgage is more than just a financial calculation. It needs to be determined in the broader context of your life situation, your psychological needs and responsibilities. If the both of you would feel best psychologically with no mortgage payments, than getting your mortgage loan paid off as quickly as possible should be your driving force.
Make sure you fully understand the difference in rates and refinance costs for each types of loan you consider.
Calculate the difference in the monthly payments between the old and new loans and then compare that to the refinancing costs of the new loan to see how long it will take to recoup your upfront costs in interest rate savings. Will you recover the costs in 3 or 5 years? Is this payback period acceptable to you?
What are your plans to stay in your home? Will you be there 5, 10 or 20 years. The time period you expect to live in the home impacts the refinancing decision you will make.
In my opinion having a 15-year loan is an emotional decision for the most part. This type of loan would force them to repay the loan faster by primarily making larger principal payments. If their goal was to be debt free by a certain time period (e.g., the time their first child enters college or by a certain age) the shorter 15 year loan would help accomplish this objective. A key consideration is that they would be requiring themselves to make extra principal payments with a 15 year loan. If they hit an unplanned financial bump in the road having a larger monthly mortgage payment could become an issue.
If they instead decided to abandon the 15 year loan and took out a new 30 year loan with a lower rate they could consider taking the difference between the monthly payment that they were willing to pay on the 15 year loan and the new 30 year loan or in their case about $500 per month and put it into savings. I suggested that they might find that in 15 years the amount these monthly savings amounts would have grown to will pay off the remaining balance of the loan or give them more assets for other needs.
Overall, the mortgage refinancing decision is not simply a quick financial decision. It must include your emotional considerations and what you are trying to financially achieve over the long-term.
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