With 30-year mortgage rates stuck below 3% and at their lowest in months, homeowners are rushing to refinance their loans while they can – and cutting their monthly payments, often by several hundred. of dollars.
If you’re considering joining the new refi rush, personal finance author and TV personality Suze Orman wants you to take a break and take a deep breath – not to spoil it.
“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.
Mortgage rates fell to an all-time low in early 2021, then rose as COVID vaccines raised hopes of a strong economic recovery. Lately, rates have fallen back into the cheap zone.
Some 2.55 million home loans were refinanced in the first quarter of this year, up 113% from the same period a year earlier, according to Attom Data Solutions. In the week ending June 11, refi claims jumped 5.5% as rates fell below 3%, according to the Mortgage Bankers Association.
Orman says the costly mistake most new refinancers probably make is automatically getting another 30-year mortgage, even if they’ve been paying off their existing 30-year loan for several years.
“It’s so bad,” she wrote on her blog.
The personal finance guru says you paid off your original loan for 14 years, then took 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 current mortgage is recent enough. More than 14 million homeowners with 30-year mortgages can now save an average of $ 287 by switching to another 30-year loan at current low rates, mortgage data and technology company Black Knight has estimated.
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 said in the blog.
Let’s say you actually still have a 30-year loan, the one you took out 14 years ago in the summer of 2007.
At the time, rates were on average around 6.75%. (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 about $ 190,000.
Why consider refinancing for a shorter term loan
Today, 30-year fixed mortgage rates average just 2.93%, according to mortgage company Freddie Mac. This is the lowest since mid-February.
If you were to refinance your $ 190,000 balance into a new 30-year 2.93% mortgage and hold on to the loan for the full term, the accrued interest would total close to $ 96,000.
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 2.24%.
With a mortgage of $ 190,000 over 15 years at 2.24%, you would pay interest of about $ 34,000 over the life of the loan. That’s $ 62,000 less than refinancing over 30 years.
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 2.87% is approximately $ 794.
The monthly payment (principal plus interest) on a 15-year refi in the amount of $ 190,000 at 2.24% is $ 1,244.
But Orman says that in recent years, 15-year mortgage rates have been so low “that you may 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 6.75% was $ 1,622. The new 15-year loan costs $ 378 less per month.
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.”
Average mortgage closing costs for a refinance are around $ 3,400, according to data from ClosingCorp. You won’t want to move until the savings from your new lower mortgage rate have paid off closing costs – and more.
If you think you are in the house for the long term, refinancing into a 15 year mortgage may be the smart choice, provided you can handle the payments. Your interest rate will be lower, and you will pay tens of thousands of dollars less in interest 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, always shop around. Collect mortgage offers from several lenders to find the best rate available in your area and for someone with your credit score. Don’t assume that the very first lender you go to will offer you the lowest rate possible.
Also, be sure to use your price comparison skills when you get your renewal notice from your home insurance company. You can easily get multiple home insurance quotes and compare prices to find what’s best for you.