With a 30-year mortgage rate below 3% and at its lowest level in months, homeowners are racing to refinance their loans while they can — and lower their monthly payments, often with hundreds of dollars.
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If you’re considering joining the new rush for refi, personal finance author and TV personality Suze Orman wants you to pause and take a deep breath — so you don’t screw up.
“It drives me crazy how most homeowners make a big mistake when they refinance,” she says.
It’s a blunder that Orman says can easily land you with much higher interest costs, even if you manage to get a mortgage rate that your friends will envy.
‘So very wrong’
Mortgage rates fell to historic lows in early 2021 and rose as COVID vaccines raised hopes for a strong economic recovery. Rates have fallen lately back in the cheap zone.
About 2.55 million home mortgages were refinanced in the first quarter of this year — a staggering 113% more than the same period a year earlier, according to Attom data solutions. In the week ending June 11, refi applications rose 5.5% as interest rates plunged deeper below 3%, the Mortgage Bankers Association says.
Orman says the costly mistake most new refinancers are likely to make is to automatically take out a new 30-year mortgage, even if they had already paid off their existing 30-year loan for several years.
“This is so very wrong,” she writes in her blog.
The personal finance guru says you paid off your original loan for 14 years and then took out a new 30-year mortgage. “Sure, the new mortgage is at a lower interest rate, but you just extended your mortgage on this home to 44 years!” she says.
When can a 30-year refinancing make sense?
The 30-year fixed-rate mortgage is America’s most popular home loan, so it can obviously be the go-to for homeowners looking to trade in their existing mortgages for a better deal.
And it makes sense if your current mortgage is fairly new. More than 14 million homeowners with 30-year mortgages can now save an average of $287 by switching to a new 30-year loan at today’s low rates, estimates mortgage data and technology firm Black Knight.
But like many experts, Orman generally recommends refinancing to a new loan with a shorter term.
“My rule for refinancing is that you should never extend your total payback period beyond 30 years,” she says in the blog.
Suppose you are indeed still holding a 30-year loan, a loan you took out 14 years ago in the summer of 2007.
At the time, rates averaged around a solid 6.75%. (Seriously, you should have refinanced sooner.) Suppose your mortgage was originally $250,000; you should now have a balance of about $190,000.
Why consider refinancing to a shorter loan?
According to mortgage lender Freddie Mac, the average interest rate on 30-year fixed home loans is only 2.93% today. That is the lowest since mid-February.
If you were to refinance your $190,000 balance into a new 30-year mortgage at 2.93%, and keep the loan for the entire term, the lifetime interest total would be nearly $96,000.
You can choose to refinance for 15 years instead. 15-year mortgages have lower interest rates than 30-year loans: the average for a 15-year mortgage is currently only 2.24%.
With a $190,000 15-year mortgage at 2.24%, you’d be paying interest of only about $34,000 during the term of the loan. That’s $62,000 less than the 30-year refinancing.
Many refinancers don’t opt for a 15-year loan because they don’t think they can afford the higher payments:
- The monthly payment (principal plus interest) on a 30-year refi of $188,000 at 2.87% is approximately $794.
- The monthly payment (principal plus interest) on a 15-year refi of $190,000 at 2.24% is $1,244.
But Orman says 15-year mortgage rates have been so low in recent years “that you might be able to” refinance your remaining balance and end up with a payment not much different from what you paid in your 30s.”
And in our example it is true:
- The monthly payment (principal plus interest) on the original 30-year mortgage of $250,000 at 6.75% was $1,622. The new 15-year loan costs $378 less per month.
How to choose
Whatever mortgage you take out for your refinancing, you want to be sure that you will continue to live in the home for a few years.
“There is no such thing as a free refinance,” Orman says. “You either pay a closing fee — which can be a few percentage points off your borrowing cost — or a higher interest rate.”
The average cost of taking out a mortgage for a refinancing is about $3,400, according to data from ClosingCorp. You won’t want to move until after the savings from that new, lower mortgage rate of yours has paid off the closing costs — and then some.
If you think you’re in the house for the long haul, refinancing into a 15-year mortgage may be the wise choice, provided you can handle the payments. Your interest rate gets lower and you pay tens of thousands of dollars less in interest over time.
With a 30-year mortgage left and the lower monthly costs may be the smarter move if you won’t be staying in the house for long. If you leave in a few years, what difference does it make if you have a 30 or 15 year loan?
Before taking out a loan, you should always look around. Collect mortgage quotes from different lenders to find the best rate available in your area and for a person with your credit score. Don’t assume that the very first lender you approach will offer you the lowest possible rate.
Be sure to use your comparison skills when you also receive your renewal notice from your home insurance company. You can easily receive multiple home insurance quotes and compare rates to find what works best for you.
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