Is It Time To Refinance Your Mortgage?

If you have been paying attention to any financial news lately, I am sure that you are aware of the historic low interest rates right now.  In a report released last week by Freddie Mac (Federal Home Loan Mortgage Corporation), they announced that rates recently hit an all time low.  The average interest rate for a 30 year fixed mortgage dropped to 2.86% last week and the average 15 year fixed mortgage was 2.37%.  For those of you that haven't been around long enough to grasp the magnitude of how low those rates are, consider that in 1981 the average 30 year rate was 16.63% and the 47 year average sits right at 8.0%.  .  What do those rates mean for a typical payment?  Check out this chart showing the monthly principal and interest payment due on the same $250,000 loan at the high in 1981, the historic average, and todays rates:

Principal and Interest payment for a 30 year $250,000 loan:
@ 16.63% (1981) =                      $3,489
@ 8.0% (historic average)=    $1,834
@ 2.86% (current rate) =         $1.035

As you can see the interest rate makes a significant difference in the monthly payment.  For the exact same house you would have been paying more than three times the current monthly payment in 1981 and 77% more based on the historic average.

So is it time to refinance your current mortgage and take advantage of these all time low rates?  People often ask me how to determine if it makes sense to go through a refinance.  There are many factors that play into this decision but I will show you how I come to this decision on my properties.  The process is a pretty simple mathematical break even analysis that goes like this:

1. Identify all of the costs that will be associated with a refinance.  These usually include things like an appraisal, origination fee, document fees, etc..  The bank or mortgage broker that you are working with should be able to get you a detailed estimate of these expenses.
2. Calculate the new mortgage payment based on the lower interest rate.
3. Subtract the new payment amount from your old payment amount to determine your monthly savings rate.
4. Divide your total expenses from step 1 by the monthly savings rate from step 3 to determine your "number of months to break even".  This is the number of months that it will take for the savings you realize from the lower mortgage payment to pay off all of the expenses you incurred to execute the refinance.
5. Decide if your time horizon for the property aligns with the break even analysis.  If the break even number is 18 months but you plan to sell the property in 12 months, you know that it would not make sense.  However if you plan to keep the property for longer than the break even, then it probably makes sense to move forward.

There are other factors that this analysis doesn't consider such as the resetting of the amortization schedule.  This means that your loan starts over for another 30 year term and you will be paying more interest than principal at the front end.  You have to decide how important this is to you.  One strategy could be to complete the refinance to get a lower payment but continuing paying the old payment amount.  In this case the extra amount would be applied to principal and the loan gets paid down much quicker.

Hopefully, this quick calculation will help you decide the value of a mortgage refinance.  Please reach out with any questions or if I can help you determine the value of a refinance.  

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