With mortgage rates back in the basement, homeowners are scrambling to refinance and lower their monthly payments, often by several hundred dollars.
If you’re planning on joining the latest refi rush, personal finance author and TV personality Suze Orman wants you to take a break and take a deep breath – not to crack.
“It drives me so crazy how most homeowners make a huge mistake when they refinance,” she says.
It’s a mistake, Orman says, that can easily charge you much higher interest charges, even if you manage to get a mortgage rate your friends will envy.
The 30-year average fixed mortgage rate has remained below 3% since early July, according to mortgage giant Freddie Mac, and the return of lows has sparked another mini-boom in refinancing.
The savings can be significant: Nearly half (47%) of homeowners who refinanced ultra-low rates in the past year are now saving at least $ 300 per month, according to a recent Zillow survey.
Orman fears that many enthusiastic refinancers are making a costly mistake: automatically looking for another 30-year mortgage, even if they pay off their existing loan that has been 30 years old for years.
“This is so bad,” writes the personal finance guru on his blog.
Say you pay off your original loan for 14 years, then take out a new 30-year mortgage. “Sure, the new mortgage is at a lower interest rate, but you just extended your mortgage payment on this house to 44!” she says.
When a 30-year refinancing can make sense
The 30-year fixed rate mortgage is the most popular home loan in the United States, so naturally it could be the go-to solution for homeowners who want to trade in their existing mortgages for a better deal.
And that’s the obvious choice if your mortgage is recent enough. At the start of last year, 30-year mortgages averaged around 3.75%, according to Freddie Mac, almost a percentage point lower than the current typical rate of 2.86%.
But, like many experts, Orman generally recommends refinancing a new, shorter-term loan.
“My rule of refinancing is that you should never extend your total payback period beyond 30 years,” she says in the blog.
Let’s say you still have a 30-year loan that you took out 14 years ago in September 2007.
At the time, rates were on average 6.40%. (Seriously, you should have refinanced before now.) Suppose your mortgage was originally in the amount of $ 250,000; you would now have a balance of approximately $ 188,000.
Why consider refinancing for a shorter term loan
If you were to refinance that $ 188,000 balance into a new 30-year mortgage at the current average rate of 2.86%, and hold the loan for the entire term, the lifetime interest would exceed. $ 92,000.
You can choose to refinance over 15 years instead. 15-year mortgages have lower interest rates than 30-year loans: the 15-year average is currently only 2.12%, not far from the recent all-time low of 2.10%.
With a mortgage of $ 188,000 over 15 years at 2.12%, you would pay interest of about $ 31,600 over the life of the loan. That’s $ 60,400 less than refinancing over 30 years.
But many refinancers don’t go for a 15-year loan because they don’t think they can afford the highest payments:
The monthly payment (principal plus interest) on a 30-year refi in the amount of $ 188,000 at 2.86% is $ 778.
The monthly payment (principal plus interest) on a 15-year refi in the amount of $ 188,000 at 2.12% is $ 1,220.
But Orman says that in recent years, 15-year mortgage rates have been so low “that you might be able to refinance your remaining balance and end up with a payment that isn’t much different than what you paid on your 30s. years “.
And in our example, it’s true:
The monthly payment (principal plus interest) on the original 30-year mortgage in the amount of $ 250,000 at 6.4% was $ 1,563. The new 15-year loan costs $ 343 less per month.
30 years of refi or 25 years? How to choose
Whatever type of mortgage you choose for your refinance, you want to be sure that you will stay in the house for a few years.
“There is no free refinancing,” says Orman. “You will either pay the closing costs – which can be a few percentage points of the cost of your loan – or a higher interest rate.”
Refi’s closing costs average around $ 3,400, according to the most recent data from research firm ClosingCorp. You won’t want to move until the savings from your new, lower mortgage rate have paid off closing costs, if not some.
If you think you are in the house for the long term, refinancing into a 15 year mortgage may be the smart choice – if you can handle the higher payments. Your interest rate will be lower, and you will pay tens of thousands of interest less over time.
Going for another 30-year mortgage and its lower monthly fee may be the smartest decision if you’re not likely to stay in the house for the long term. If you’re leaving in a few years, what does it matter if you have a 30-year or 15-year loan?
Before taking out a loan, shop around. Don’t assume that the very first lender you go to will offer you the lowest possible rate.
Collect mortgage offers from several lenders to find the best rate available in your area and for someone with your credit score. If you don’t know what yours is, it’s easy today to check your credit score for free.
Then, reuse your price comparison skills when you receive your renewal notice for your home insurance. You can easily get multiple home insurance quotes and compare rates to find what’s best for you.
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.