If you’re looking to supercharge your savings, you’ve got to find a few ways to make a big dent. And there aren’t many bigger expenses than your mortgage.
Here’s the problem: Saving money on your mortgage isn’t that simple. Once you’re locked into these massive loans, there are only a couple of ways to save. You can either throw extra toward your mortgage payments each month, you can refinance, or you can do both.
So, what’s refinancing all about… and can it help you save money? Well, that depends. Mortgage rates have been low for the better part of a decade, but interest rates appear to be on the rise. If you have the opportunity to save, you better start considering a refinance now. Let’s dig in to find out more!
Types of Refinancing
Refinancing your mortgage isn’t something to be taken lightly. Essentially, you’re taking out a new loan to replace an old one. Your credit score will take a small hit with a hard pull, and – like with almost any new loan – there are fees to consider. However, if the situation is right, refinancing your mortgage could easily save you tens of thousands of dollars in interest charges.
When it comes to refinancing your mortgage, there are two basic types of refinancing available:
- Rate and Term Refinancing – This is exactly what it sounds like: You refinance the rate and/or the term of your current mortgage. Essentially, you’re taking out a new loan with a new (hopefully lower) interest rate at a new term length. This is the type of mortgage refinancing arrangement we are going to focus on in this article.
- Cash Out Refinancing – Hold it right there, buster! We;re not a big fan of this method. The goal is to help you build wealth through a refinance, not destroy it. With a cash-out refinance, you cash out the equity you already have and use it to purchase something else (like new floors, an addition, or to pay off other forms of debt). All you’re doing here is re-upping on the debt you worked so hard to pay off. So, while we have to mention this for the sake of completeness, Homie don’t play that. Stay away from the cash out refinance.
Advantages of Refinancing Your Mortgage
Refinancing your mortgage can provide a number of different benefits. Here are a few of the most important:
- Save money on interest. – By refinancing your mortgage to a lower rate, you can save a bundle on interest charges. Let’s assume that you have 30-year $150,000 mortgage at a fixed 6% interest rate. Over the course of your loan, you’ll end up paying about $140,000 in interest alone! If you can refinance it to a fixed 3% interest rate, you’ll save a little over $62,000 in interest charges over the course of your loan in interest. That is real money, money that you could be using to save for retirement, college, travel, or whatever you want.
- Lower your monthly payment. – Using this same example, you could lower your monthly payment by about $175 per month. Save the difference or put it back into the mortgage to pay it back faster. Either way, you come out a winner.
- Reduce the term. – Another thing you can do is keep the same payment but reduce the term length. So, if you score a refinance of this same loan at a fixed rate of 2.75%, you can keep roughly the same monthly payment ($810/month) but reduce your term length by 10 Years. This would save you a whopping $95,000 in interest over the life of the loan! Not bad just for doing a little leg work.
- Closing costs. – As with all new loans, you’ll probably have to pay a pesky origination fee to open it up. Generally, this is going to run you about 1% of the total loan amount. So, on a $150,000 refinance, you’re looking at approximately $1,500. In addition, there may be other fees (like appraisal fees, title insurance, etc.) which could push the cost up to about $2,000 on this example. Always keep this in mind when determining if a refinance is a good move for you.
- Don’t extend the term. – Unfortunately, too many people use a mortgage refinance as a way to dig themselves deeper into debt. Even with the rate and term refinance option, you can get yourself into trouble. Remember that mortgage interest is front-loaded on your loan. That means you pay far more in interest at the beginning of your loan than at the end. If you continuously refinance into a term that is the same or longer than the original term, you may be costing yourself ginormous amounts of equity in the home. You’re just jumping on spinning on a hamster wheel, paying interest but never accruing any real equity. Additionally, if you extend the term, you may save yourself some money on monthly payments right now. However, you’ll almost certainly cost yourself thousands in interest over the long-run. When you buy a home, you need to look at the long-game. Don’t just do what is convenient now.
How to Do it Right
Now that we’ve covered all of the basics, let’s talk about how to refinance your mortgage the right way. As a general rule of thumb, you should wait until you can save at least 1 percentage point in interest to refinance your mortgage. Why? Again, you’ll have to pay fees on your new mortgage, so you’ll want to make sure that you’re saving enough to cover those costs.
If you’re looking to save money on interest, the 1% rule works pretty well. But, before applying any rules of thumb, you need to consider what you’re trying to accomplish with the refinance. If your main goal is to lower your payments, then you can generally refinance your mortgage at the same rate but extend your term. Yep, you’ll definitely lose money on interest payments, but it could help you get out of an immediate jam. (Again, we don’t recommend this route. Ideally, you would get out in front of that problem by saving more and spending less to begin with.)
For those who are interested, here is the actual calculation to determine when you’ll break even on your closing costs:
Closing costs / Monthly Savings = Refinance Break-Even
So, for our example:
$2,000 / $175 Monthly Savings = 11.43 Months to Break Even
Now, that you know your break-even point, you can decide whether or not the refinance makes sense for you. Please note that this is just a calculation of how long it will take you to break even on your closing costs. It works best when you keep the same term. If you extend your term, you’re still going to end up paying more in interest costs.
Who Should You Use to Refinance
When it comes to refinancing, the whole goal is to get the best rate possible. Otherwise, why refinance right?
To get the best deal, you should compare rates with multiple lenders. Personally, I love LendingTree.com because they make this super simple. When you go through their system, you can stack up to 5 different lenders against each other. So, instead of running from bank to bank, you can see a bunch of different rates all in one place.
Is Refinancing Your Mortgage Right For You?
If you want to save more money, refinancing your mortgage could be just the boost you need to supercharge your savings. By refinancing to a lower rate, you could potentially save yourself thousands in interest charges, lower your monthly payments, or both. Remember to carefully consider all of the advantages and disadvantages before pressing forward. Do the math, see if it works out in your favor, and use it to get ahead!
This is the fourth piece in our Supercharge Your Savings series. To read more, check out the articles listed below: