Pay off your mortgage before retirement, and that's one less bill you'll have to worry about when you're on a fixed income.
-- Suze Orman
It's a good goal to be rid of your mortgage by the time you retire. One tool to help you achieve that is by refinancing your mortgage. Before refinancing, though, there are three key things you need to know.
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1. Refinancing means getting a whole new mortgage
First off, understand that when you refinance your mortgage, you get a whole new mortgage. It's not just a matter of changing a term or two, such as the interest rate, in your existing loan contract. Getting a new loan, meanwhile, means doing just about everything you did when you got your original loan.
Refinancing will typically feature closing costs, such as loan origination, appraisal, title search fees, and title insurance premiums, which can total between 2% and 5% of the loan's value. You might be able to get a new mortgage that charges no closing costs, but there will be costs -- they will just be folded into the amount borrowed and will likely result in a somewhat higher interest rate.
A new loan will also mean that your lender (which might be your original lender or a new one) will need to make sure you're a good borrowing candidate. Your credit score will be checked -- and if it's not good, you'll be offered higher rates -- and you'll need to provide documentation substantiating your income, assets, employment, and other financial matters. To get an idea of just how much your credit score matters, the table below reflects recent rates for someone borrowing $200,000 via a 30-year fixed-rate mortgage:
|
FICO Score |
APR |
Monthly Payment |
Total Interest Paid |
|---|---|---|---|
|
760-850 |
3.904% |
$944 |
$139,766 |
|
700-759 |
4.126% |
$969 |
$148,990 |
|
680-699 |
4.303% |
$990 |
$156,434 |
|
660-679 |
4.517% |
$1,015 |
$165,541 |
|
640-659 |
4.947% |
$1,067 |
$184,183 |
|
620-639 |
5.493% |
$1,135 |
$208,492 |
Data source: MyFICO.com, as of early March 2017.
Thus, refinancing might not be your best move if you have a poor credit score now, as you may not be offered a much better rate than you have now.
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2. Choose the right kind of new mortgage
Next, remember that if you're going to the trouble of getting a whole new mortgage, you won't necessarily be best served by just getting a fresher version of your original loan. Consider all the alternatives. For example, switching from the typical 30-year mortgage to a 15-year one will likely get you higher payments, but it will also likely get your home paid off more quickly and cost you much less in interest payments. Know that mortgages can be had for time spans other than 15 years and 30 years as well. Know, too, that if you don't want to lock yourself into the higher payments of a 15-year loan, you can always make extra payments on a 30-year loan in order to shorten its life. Just be sure when you get pre-approved for a mortgage or start finalizing your new loan that there is no penalty for prepayments.
Meanwhile, if you originally took out an adjustable-rate mortgage (ARM) with an ultra-low rate for its first five years, you may be nervous now that interest rates are starting to inch up. If you don't like the prospect of rising mortgage payments in future years, you might refinance to a fixed-rate mortgage, ending up with payments that might be higher than what you face now but that won't rise anymore. Similarly, if you know that you won't be in your current home more than a few more years, you might refinance into an ARM with lower rates.
As you look into your refinancing options, be sure to compare mortgage rates to find the best ones with the best terms. Check online and with local credit unions and banks. Mortgage brokers can also be helpful, especially if you don't have the highest credit score.
Image source: Pixabay.
3. Refinancing isn't always a great move
Finally, know that refinancing isn't always the right thing to do. If you won't be staying in your home for too many more years, for example, your savings from the new loan may not make up for the closing costs of the refinancing. If your closing costs total $3,600 and you're saving $100 per month, you'll need to be in the home for 36 months in order to break even. After that, you'll be coming out ahead.
If you had 17 years left on a 30-year mortgage and you refinance into a new 30-year loan, understand that you'll start the clock ticking all over again. If you're only a decade from retirement, you're setting yourself up for 20 years of payments in retirement, which isn't ideal. (You could address this issue by making prepayments against your balance aggressively before retiring, in order to shave years off the loan.)
Remember, too, that mortgages start out with most of your payments going toward interest and relatively little going toward paying down your principal. As time goes on, interest will make up a smaller portion of your monthly payment. Starting with a fresh loan will mean that you start paying a lot of interest again. This can seem nice when you're deducting mortgage interest, but it also means you're not building equity very quickly.
These are the kinds of issues to consider if you're thinking about refinancing your mortgage. Doing so can be very smart, saving you a lot of money -- but it's not always the right thing to do.
