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Should You Refinance Your Mortgage?

When the Federal Reserve began cutting interest rates in July 2019, homeowners jumped at the chance to refinance their mortgages, with such activity reaching a three-year high in August.1

But locking in a lower interest rate won’t always save you money in the long run. Here are four common reasons to refinance—and what to consider about each.

Reason 1: Cut your interest rate

In September 2019, more than half of all borrowers with 30-year fixed-rate mortgages could have saved at least three-quarters of a percentage point on their interest rate by refinancing, according to mortgage-analytics firm Black Knight.2

However, locking in a lower rate may not be enough, especially if you plan to move in the next few years. If you can’t make back what you paid in closing costs and other expenses by the time you sell, refinancing probably isn’t worth it.

Even if you plan to remain in your home, you need to think about how far along you are in your current loan. For example, if you’re 10 years into a 30-year loan and you refinance with another 30-year loan, you’re potentially adding 10 years to the time it will take to pay off your home. To justify that extra decade, you’d have to save a significant amount of money on your monthly mortgage payments (see “Loan vs. loan,” below). Otherwise, you’d need to commit to paying off the loan more quickly than required using the money you freed up by lowering your monthly mortgage payment. Or you could invest that money in the hope of generating enough returns to offset your total refinancing and interest costs.


Loan vs. loan

Even a 0.75 percentage point cut to your current loan wouldn’t be worth it over the life of your new 30-year loan.

 

Current loan

$400,000 @ 4.25%

30-year term

Refinanced loan

(original loan minus principal paid to date)

$317,773 @ 3.50%

30-year term

Monthly payment

$1,968

$1,427

Years remaining

20 years

30 years

Interest paid to date

$153,904

$0

Total interest due over life of loan

$308,393

$195,926

Total interest paid

$308,393

$349,830

(interest paid to date on current loan plus  total interest due on refinanced loan)

Source: Schwab Center for Financial Research. Figures have been rounded.  This example is hypothetical and provided for illustrative purposes only.

Reason 2: Replace an adjustable-rate mortgage

Today’s rates don’t have much room to go lower, but they have plenty of room to rise. Although we don’t expect rates to increase significantly anytime soon, the benchmark 30-year fixed-rate mortgage did rise in mid-December to 3.93% from 3.90%, according to Bankrate’s weekly survey of large lenders.And it was 5.04% only a year earlier.3

Hence, refinancing might make the most sense for borrowers with an adjustable-rate mortgage (ARM), which is susceptible to rate hikes once the loan’s initial fixed-rate period expires. Locking in today’s relatively low rates with a fixed-rate mortgage can help such borrowers sidestep future rate increases.

Be that as it may, fixed-rate mortgages typically come with higher interest rates than ARMs, which may mean a higher monthly payment, at least initially. In the end, weigh your expectations about future rate cuts or increases against the peace of mind that comes from locking in a fixed payment for the life of your loan, as well as whether you could afford a higher payment if adjustable rates rise.

Reason 3: Get rid of private mortgage insurance

If you pay for private mortgage insurance (PMI)—which is usually required when you have a conventional loan and make a down payment of less than 20%—it may be possible to eliminate that expense by refinancing.

However, if you don’t plan on staying in your home for much longer—or if your potential new rate isn’t substantially lower than your current rate—it may make more sense to stick with your current loan, as demonstrated in “Loan vs. loan,” above.

Of course, if you believe the value of your home has risen to the point where your equity stake no longer requires you to have PMI, you can also ask your bank for a reappraisal. And in any case, your PMI payments will automatically terminate once your principal balance reaches 78% of your home’s original value.

Reason 4: Pay off more expensive debt

If you’re carrying significant amounts of high-interest debt, you might be considering a cash-out refi, which allows you to borrow extra funds against the value of your home.

Using low-rate funds to pay off high-rate debt may be a smart strategy, provided you’re disciplined enough to keep your high-rate debt under control in the future. But it goes without saying that a cash-out refi will increase your monthly mortgage payments, potentially putting your home at risk should the payments become unmanageable.

Compare and contrast

Whatever your reason for considering a refi, make sure you do a thorough cost-benefit analysis before pulling the trigger. (There are a number of online mortgage calculators, such as the one available at bankrate.com/calculators, that can help you run the numbers.) A lower monthly payment may be your goal, but it’s possible you could end up paying more in the long run.

1Richard Leong, “U.S. home refinancing activity hits three-year high: MBA,” reuters.com, 08/21/2019. | 2Mortgage Monitor, 09/09/2019. | 3Mortgage rates edge up as home prices surge,” bankrate.com, 10/24/2019.

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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