I’ve been hawkishly watching the interest rates since I closed on the house four years ago, but the drops weren't enough to warrant the refinance. This week, the math finally made sense---rates dropped, and I executed. Hello, interest savings! It's something to be grateful for in the current crazy.
A refinance, or refi for short, refers to revising and replacing the terms of an existing credit agreement (usually a loan or mortgage).
Reasons to Refinance
- Lower Interest Rates
- Better terms for the loan (monthly payment or length)
- Needing cash? A cash-out refi can be a good option
Lower monthly payments can be achieved by reducing the interest rate or extending out the term.
Closing Costs
Closing costs (usually 1-2%) offset the benefits of a refinance. The closing costs should generally be rolled into the loan, rather than paid up front.
Before you use cash on hand to pay the closing costs, make sure to compare (1) the interest paid over the life of the new loan and (2) the interest paid over the life of the old loan if you make a lump-sum payment instead. Option 2 might actually save more money!
If you have a pile of cash, lower monthly payments may also be achieved through a recast, which could save on closing costs and be more cost effective in the long term, depending on your goals and potential refinance options.
Old Mortgage
My 3.75% had almost 26 more years to go.
I'd never paid extra on it, in part because I couldn't. Longtime readers might remember how far I stretched just to “afford” this house—the proceeds from my first house, every penny I had, plus a 401(k) loan. My Airbnb helped cover the cost of the house, giving me breathing room in my anti-budget. When I got married, our combined incomes gave us decent flexibility, and I no longer needed to rent out space. We had other financial goals that took priority over early mortgage payoff, including beefing up the retirement accounts.
Refinancing usually only makes sense if the rate is at least 0.5%-1% cheaper. I already had a low rate, and the 30-year was staying above 3%, so the math hasn't mathed in favor of a refinance. Brokers called me regularly, offering "fabulous payment reductions," but the reduction was solely because the terms would be reset to 30 years. In some cases, high closing costs meant my payments went up. The goal is to pay off the mortgage, so extending the length was actively unhelpful.
Interest rates for 15-year loans are historically cheaper than 30-year loans by half a percent, but the monthly payment is higher due to the shorter payoff. With the shorter term, there's just less time for interest to accrue. Paired with closing costs, the "interest savings" brokers tried to sell me was often entirely artificial. If I'm only "saving" because I'm paying it off faster, I don't need to refinance to a 15-year term for that---I can just pay the extra on the current mortgage.
If there was savings from refinancing to a 15-year, it was always small---$10k or less. I wasn't comfortable with giving up the flexibility of a lower payment for such a marginal difference in interest over the life of the loan. It wasn't until the most recent rate drop that it actually made sense.
New Mortgage
A sweet 2.25% for 15 years. The payment increased by about $525/month.
Total interest savings, comparing our old loan to our new loan, is over $100k---and over $20k of it comes specifically from the interest rate drop. This is despite increasing the principal by about $14k (rolled-in closing costs). If we keep on schedule, we'll be paid off in 2035. With such a low interest rate, there isn't much of a point to paying it off early. The money is theoretically better invested in the market.