Historically low interest rates have made now a good time to be a homeowner. According to the Federal Home Loan Mortgage Corporation, also known as Freddie Mac, the average interest rate on a 30-year fixed-rate mortgage in mid-September 2021 was 2.86. Just ten years earlier, the average rate was 4.09. That’s a significant dip, and one that’s saving today’s homeowners tens of thousands of dollars over the life of their mortgages.
Interest rates dipped during the pandemic and have remained low ever since. That’s unlikely to last forever, which has given many homeowners a sense of urgency regarding refinancing. Refinancing can be financially advantageous, but there are some things homeowners should know prior to contacting their lenders.
Refinancing does not always save money over the long haul
It’s hard to blame homeowners who jump at the chance to refinance their mortgages. Refinancing is often associated with significantly lower monthly payments, and such savings can be used to finance home improvements, pay for tuition or build retirement nest eggs.
However, homeowners won’t necessarily save money over the long haul if they’re refinancing an existing 30-year mortgage with another 30-year mortgage.
The mortage experts at Mortgage Calculator note that a Change Terms mortgage refinance is characterized by a shift to a loan charging a lower interest rate.
The initial savings with such a refinance are undeniable, but changing from one 30-year to another 30-year restarts the mortgage clock, which can add years to the time homeowners will be repaying their debt.
As a result, homeowners may end up paying more interest over time than they might have had they just kept their initial mortgage.
Homeowners interested in a Change Terms refinance may want to look into switching from a 30-year to a 15-year mortgage. A shorter term mortgage will increase the monthly payment, but the loan will reach maturity much faster, greatly reducing the amount of interest homeowners will pay over the life of the mortgage.
Refinancing can be costly
Lower monthly payments might be the number that catches homeowners’ eyes as they look to refinance, but it’s important that homeowners recognize that refinancing is not free. In fact, the personal finance experts at Kiplinger note that refinancing incurs many of the same costs that homeowners had to pay when they signed their initial mortgage papers. That includes fees, taxes and appraisal costs.
These costs are sometimes paid up front, but they also might be rolled into the loan balance. In the latter instance, homeowners could be paying interest on their refinancing costs. Homeowners who are refinancing solely because of lower interest rates should know that some lenders raise interest rates to compensate for refinancing costs. That can negate the savings and end up costing homeowners more money than the original mortgage.
Refinancing is an option for homeowners who want to save money. Homeowners can speak with a financial advisor to determine if this is the best way to save money over the long haul or if refinancing will ultimately cost them more over the life of the mortgage.
Homeowners who haven’t yet refinanced but are considering doing so can consider two types of mortgage refinancing options.
Cash-Out vs. Change Term Mortgage Refinancing:
Cash-out
According to the mortgage experts at MortgageCalculator.org, a cash-out mortgage extracts equity from a home. U.S. homeowners have more than $6 trillion in untapped home equity, and that can be used to pay for various expenses, including home improvements, tuition and medical costs.
The financial experts at Nerd Wallet note that a cash-out refinance works by replacing an existing mortgage with a new home loan for more money than is owed. The difference is then given to the homeowners in cash, which they can use for the aforementioned expenses or other costs, including paying down high-interest debts.
Lower interest rates typically entice homeowners to refinance, but if homeowners are solely looking for lower rates, then a cash-out refinance is probably not the best option.
Change term
Also known as a rate-and-term refinance, a change term is a refinance characterized by shifting to a lower interest rate. Homeowners also may refinance utilizing a change term to shift from an adjustable rate mortgage to a fixed-rate loan. Change term refinancing also is popular for homeowners who want to switch from the standard 30-year fixed rate to a 15-year fixed rate. This can shorten the term of the loan, saving homeowners a lot of money in interest over the 15-year period.
However, homeowners should note that switching from a 30-year to a 15-year loan will lead to higher monthly payments. This switch might be most suitable to individuals earning significantly higher salaries than they were at the start of their initial mortgages and/or homeowners whose cost of living has recently decreased due to certain changes, such as children graduating from college.
Homeowners also may consider change term mortgages to lower their monthly payments. In such instances, they simply swap out an existing 30-year mortgage for a new 30-year mortgage with a lower interest rate. That can save money up front, but homeowners should calculate the long-term interest costs of switching to a new 30-year mortgage. The lower monthly payments might be tempting, but homeowners may ultimately pay more in interest over the life of both loans by switching to a new 30-year mortgage.
