Should I Refinance?

"Hey Lori, I saw online that interest rates are currently lower than my interest rate.  Maybe I should refinance."

I get this call from past clients all the time, and my answer typically surprises them.  "It might make financial sense for you to refinance, but - truthfully - it might not."

"What??  But the rate is lower!  Why wouldn't it make financial sense?"

It's a good question, and one I'm happy to answer for them - and for you!

The Benefits of Refinancing

There definitely can be benefits to refinancing.  The main four are:

1. Lower Interest Rate - This needs little explanation.  If you could pay a lower interest rate on your loan than you are paying now, that's a good thing.
2. Lower Monthly Payment - Typically refinancing also gives you a lower monthly payment which is nice. 
3. Shorter Term - Sometimes people refinance to get a shorter term as well, changing from a 30 year loan to a 15 year one, for example.  In cases like that, the monthly payment might actually go up even though the rate goes down just because they're paying it off faster.  They are typically saving a TON of money on interest with that shorter term, though, so it's still a good thing. 
4. Removing/Reducing Private Mortgage Insurance (PMI) - this is one that people often don't even think of.  If their home value has gone up since they bought it and they are currently paying PMI as a part of their payment, refinancing could remove or reduce the cost of that PMI.

So....WHY did I say it might not make financial sense to refinance?  There truly are situations where refinancing to a lower rate will cost you more money.  Let's look at those now.

Paying More with a Lower Interest Rate

The thing that people often don't realize about refinancing is that a lower interest rate doesn't automatically equate to less interest paid.  Why is that?  Because refinancing typically resets the loan term.

Let me give an example.  Let's say your mortgage balance is $70,450 and your interest rate currently is 4.75%.  You've been paying on the loan for 5 years now and you have an opportunity to refinance to 4.00%.  The closing costs will be $2,000 and will be rolled into the new loan.

If you continue to pay your loan as-is without refinancing, you will pay $50,056 in interest between now and the time it's paid off in 25 years.  If you refinance into a new 4.0% loan though, adding in your closing costs, you will actually pay $52,069 in interest by the time the loan is paid off.  

Why are you paying MORE interest with a lower interest rate?  Because by refinancing, you are stretching your loan back out to 30 years.  Adding in those 5 additional years will cost you more in interest, even with the lower rate.

Now, could you take the new, lower rate and pay it back over 25 years?  Absolutely!  And your payment would still drop $19.25/month if you did this.  The truth of it is though, few people actually do that. They probably intend to but, when the bill comes showing that new, lower payment, they just pay that minimum amount due.  By doing that they end up paying more for their mortgage than if they had left their loan unchanged.

Adding Permenant Mortgage Insurance

Paying more in interest isn't the only reason to potentially pass on refinancing, though.  If you currently have a FHA mortgage and are considering refinancing into another FHA mortgage,  you may be strapping yourself to unexpected mortgage insurance for the life of your loan.  

HUH??

Let me explain.  If a homeowner currently has a FHA mortgage and that mortgage was taken out before June 3,  2013, the mortgage insurance portion of their monthly mortgage payment will eventually go away.  When they have enough equity, their lender will remove that cost from their monthly payment, never to return.

On June 3, 2013 though, FHA changed that.  The majority of FHA loans taken out after that date will have mortgage insurance for the life of the loan, meaning ALL 30 YEARS.  

How does this impact your refinancing decision?  If you are going from a FHA mortgage to a FHA mortgage, if you intend to stay in your home for awhile and if you currently have a FHA mortgage that will drop that mortgage insurance charge in time, refinancing into a new loan that will have mortgage insurance charged all 30 years doesn't make sense, even if the interest rate is lower.

The Bottom Line

So what does this mean to you? Should you refinance if the rates are lower or shouldn't you?

It truly depends on your unique situation.  Some people should and some people really shouldn't.

Here's what you should do.  If you are curious about refinancing, contact a lender and ask them if it makes sense for you.  If they automatically say "Yes!", hang up and call someone else. They're not thinking about what's best for you.  They're thinking about getting another loan.

If they say "It depends", though, talk to them some more.  Or, even better - just call me!  I'm happy to do the math with you to see if refinancing makes sense or not.  If it does, I'll gladly help you save some money.  And if it doesn't, I'll tell you that too.

Lori Hiscock is a Sr. Loan Officer at Ruoff Home Mortgage‘s South Bend office.  One of Michiana’s top mortgage loan officers, Lori started her lending career in 1995 after obtaining her bachelor’s degree in Finance from Western Michigan University.  You can connect with Lori Hiscock or apply online here. NMLS#404320.

Ruoff Mortgage Company, Inc. is an Indiana corporation licensed by the Indiana Department of Financial Institutions (DFI) and operates with the following licenses:

Indiana-DFI First Lien Mortgage Lending License #10994;
IL Residential Mortgage Licensee #MB.6760734;
Michigan 1st Mortgage Broker/Lender License #FL0017496.

Ohio Mortgage Broker Act License #MBMB.850220.000

The Florida Office of Financial Regulation License #MLD1182