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Elliot Raphaelson

Elliot Raphaelson

Many readers have written of late to ask whether they should refinance their mortgages. It’s not surprising: Mortgage rates have dropped significantly. The average 30-year fixed mortgage rate is under 3.8%, down from around 4.5% in June 2018.

Refinancing is basically replacing your mortgage with a new one with different terms and conditions. The term most people think about is the interest rate, but others include length of payback period and whether the loan is fixed or adjustable.

A common reason to refinance is the opportunity to reduce interest costs. Another is to reduce the monthly payment, which you might pursue if your financial condition has changed because of the death of a spouse, divorce or job loss. Or you may wish to switch from the uncertainty of an adjustable rate to the assurance of fixed payment. Refinancing to reduce the payback term — say, from 30 years to 15 — is a good way to limit future debt obligations. Finally, refinancing is a common way to free up capital if your home has increased in value.

If your objective is to reduce your interest expenses because your existing mortgage rate is higher than prevailing mortgage rates, it’s helpful to determine the break-even point of a refinance — i.e., how long it will take to recover the closing costs of the new mortgage. Suppose the total closing costs will be $6,000, to be rolled into the new loan. Assume further that your new monthly payment will be $200 a month less than the current mortgage payment. The break-even point is 30 months ($6,000 divided by $200). After 30 months, you will have saved enough to cover the closing costs, and you will be saving $200 a month thereafter. You also can ask the new lender to make the term of the new mortgage the same term as the remaining term of the old mortgage. For the first few years of a new conventional loan, most of your payment will be applied to interest costs, so despite the break-even point of 30 months, rolling the closing costs into the new loan means the outstanding loan balance on the new loan may still be higher for a significant period. Take this into consideration before you refinance if you plan on selling in the next few years.

One way to pay lower interest is to shorten the term of the loan. Financial institutions will offer lower interest rates for a 15-year mortgage than for a 30-year mortgage. Determining which option is best for you depends on your current financial situation and your long-term objectives. If you are more concerned with minimizing near-term monthly payments, you might favor a 30-year mortgage. If it is more important to eliminate debt as soon as possible, then you should favor the 15-year mortgage.

Choosing between a fixed- and an adjustable-rate mortgage can be tricky. No one can predict future mortgage rates. If you expect your income to be flat or reduced in the future, then you should opt for the fixed-rate option.

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Elliot Raphaelson welcomes questions and comments at raphelliot@gmail.com.

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