Dear Carrie: I’m thinking of refinancing my mortgage since I know interest rates are going up. Does it still make sense or have I missed the boat? — A Reader
Dear Reader: Rising short-term interest rates are on a lot of people’s minds these days. For savers, it’s a plus, but borrowers — especially those with credit card balances — may see their payments creep up over time. However, for homeowners with a mortgage, it’s a slightly different story.
While adjustable rate mortgages may be affected by short-term rate increases depending on the benchmark used to adjust the rate, fixed mortgage rates tend to be more closely aligned with the 10-year Treasury note. So, for instance, the recent increase in the short-term federal funds rate is unlikely to cause rates for a 30-year fixed mortgage to increase dramatically. Plus, even though we’ve seen rates inch up, when you compare today’s mortgage rates to historical norms, current rates are still a good deal.
But rates aside, deciding whether or not to refinance depends on a lot of personal factors. So you first need to ask yourself some questions and look at some specifics.
What’s Your Goal?
People refinance for a lot of reasons. Do you want to lower your monthly payment? Reduce the length of your mortgage? Take out extra money for home improvements? These are important initial questions.
If decreasing your payment is a top priority and you can lower your interest rate by .5 to 1 percent, it’s probably worth the effort. For instance, lowering the interest rate on a $350,000 30-year fixed mortgage by 1 percent could lower your monthly payment by about $300 a month.
On the flip side, if your goal is to shorten the length of your mortgage and you refinance that amount for 15 years, your monthly payment would go up, but you’d save a considerable amount in interest over the life of the loan.
How Long will You be in the House?
Refinancing usually involves paying points and fees. Points basically represent interest you pay upfront to get a lower rate on your loan. It’s not uncommon for points and fees to add up to 3-6 percent of your loan. You can pay this out of pocket or, often times, add them to the balance of your loan. (One positive: points on a refi are tax deductible, amortized over the life of the loan. Should you refi again, you can deduct any unamortized points at that time.)
However you pay them, it will take time to get to the breakeven point where these additional costs are offset by the lower rates, so you have to think realistically about how long you intend to be in your home. If you plan to sell in the near future, the extra cost of refinancing may outweigh the monthly short-term savings.
How Much Home Equity do You Have?
Just like with the down payment on a first mortgage, if you have less than 20 percent equity in your home, you’ll likely have to pay private mortgage insurance. PMI fees can range from less than half a percent up to about 1.5 percent of your loan. While that may not add a considerable amount to your payment, if your goal is to reduce your monthlies and you have very little equity, you may want to reconsider.
Do the Math
As you can see, it becomes a numbers game. A good way to start is to run some different scenarios using an online mortgage refinance calculator. That way you can see how it all adds up and decide on the optimum rate and loan term for you. In this interest rate environment, it could be smart to move from an adjustable rate mortgage to a fixed — depending on the rate, of course.
Also be aware that to get the best rate, you need to have a good credit rating, so you might want to begin the process by looking at your debt ratio and paying down outstanding credit card balances.
And if you’re increasing your loan balance or shortening the loan term, each of which could increase your monthly, make sure you’re being realistic about your ability to handle the new payment from your income. The last thing you want to do is to shortchange your retirement savings or emergency fund for the sake of your mortgage.
Carrie Schwab-Pomerantz, CERTIFIED FINANCIAL PLANNER ™ is president of the Charles Schwab Foundation and author of “It Pays to Talk.” You can e-mail Carrie at firstname.lastname@example.org.