Homeowners: Why a Refinance Now Could Pay off Big
Ep 173 | Author: Emilie AriesDisclaimer: I am not a personal financial advisor or money expert. This post is for informational purposes only. It should not be considered legal or financial advice. You should consult with an attorney or other professional to determine what may be best for your individual needs.
Last week, the Federal Reserve announced that they were dropping interest rates yet again, to help shore up an uncertain economic forecast. This reminded me of one big way Brad and I took advantage of lowered interest rates this year that I wanted to share: our mortgage refinance story.For those of you whose eyes glaze over when I begin talking about wonky money stuff, or if you're paying rent in lieu of writing mortgage checks each month, you might want to start off by reading/listening to some of my earlier personal finance posts and podcasts I've produced over the course of my own money journey I've been on over the past two years:
For the rest of you - especially the homeowners or aspiring homeowners reading this - listen up: you may be able to save tens or even hundreds of thousands of dollars by refinancing right now.
Here's how we saved $190k+ by refinancing
For some background: we bought our home last December for $375k after it went on the market for $400k. It sat on the market for nearly 2 months (which was exceptionally rare in Denver's hot market, but there was a slight slump in the real estate market in October of 2018 and we pounced!). Since it had been sitting on the market for so long, we were able to negotiate $10k off asking and a $5k reduction in closing costs, since there were a few fixes we had to make to the home right away.
(Have I mentioned, by the way, that I love a good negotiation?)
At the time, the interest rates had been slowly rising since the economy was strong, so after putting our 10% down payment down, the mortgage we secured for the rest was given to us at a 5.125% interest rate on a 30 year term. Mind you, 30 years is pretty standard, and most homeowners opt to stretch out those payments over 30 years to lower the monthly amount due.
But if you look closely at those 30 years of payments, you'll notice the interest payments you're making can really add up. According to our terms, over the course of the next 30 years, we'd end up paying a total of $329,536 in interest alone (?!?!) and another $337,258 in principal, meaning, that's what would actually go to paying down the cost of the house.
That means we'd be paying 96% of the worth of home in interest to the bank. This is how banks make their money. For us homeowners, that means we're essentially paying for the value of our home twice.
Our monthly mortgage payment was $2099. Not crazy high for the lovely (albeit, small) home we purchased in a city, but not nothing.
Why Federal Reserve rates matter
When the Federal Reserve started dropping interest rates again this year, Brad and I read about a an interesting refinancing rule of thumb: if you can secure an interest rate that's an entire point lower than the one you currently have, most bankers consider it worth pursuing. When the Fed dropped rates, many banks chose to do the same (while that relationship is not direct, there's a lot of indirect pressure to follow the Fed).We started by shopping around. We got in touch with our existing bank that held our mortgage, used RocketMortgage by QuickenLoans (which, for full disclosure, has sponsored my podcast over the years) to get a bunch of other bank's quotes, and contacted the bank we use for the majority of our personal finances, Bank of America. Bank of America offered a price match for the best offer we could find anywhere and had the best customer service, so we decided to move forward with them.
Then, the real work began. Refinancing is basically just like re-buying your house, from a financial perspective. That means, there was an absolute mountain of paperwork to do. You need to provide all kinds of financial statements, tax records, and home information (including getting a new appraisal of your home) all over again. It's like you need to re-qualify for your loan, this time (in our case at least) with a new financial institution.
Over the following month, I probably did about 10 hours of paperwork associated with the refinance. We had the house appraised by Bank of America and it came it at $400,000, as I thought it should, given what homes were selling for in our area. But it was actually difficult for us to make that case at first, since the sale price less than a year ago was $15k lower because of my negotiation. Fortunately, it came in at $400k anyway, and essentially we earned $15k in equity in our home in less than a year of living here - woo!
We refinanced into a shorter-term loan
This entire time, we were aiming to refinance from a 30-year to 20-year mortgage at a lower interest rate than the 5.125% we originally had. The goal was to reduce our overall interest obligation without increasing our monthly payment too much. If your goal is to lower your monthly mortgage payment, that can also be obtained through refinancing, but typically means you wouldn't shorten your loan term. After all, if you ever want to shorten your loan term, all you had to do is make extra payments to your mortgage principal when you're able to on a month-to-month basis.
Once we got everything approved through underwriting (the bank department that decides if you qualify for their loan), our new loan offer looks like this:$337,000 was the total loan amount (what we owed on the house.)Our new fixed interest rate is 3.625% (that's 1.5% lower!)Our new term was 20 years (that's 10 years fewer!)Our monthly mortgage payment due went up by $127 a month, some of which is going to PMI (private mortgage insurance), which will go away in a few years and is too wonky to get into right now.
So for all the hassle of refinancing, and for paying another $127 a month right now, we'll end up paying off our home 10 years faster, and paying a total of $338,919 to principal and PMI and only $139,316 to interest. That interest payment is now $190,220 LESS than what we would have paid in our original mortgage.
Granted, this whole financial process cost us about $5,300 in closing costs (the refinancing process does involve some costs), but we were able to bundle most of those costs into the new loan itself, so it didn't really affect our cash flow. We did have to bring $927 in cash to the final closing date to cover the cost of restructuring the mortgage, but then a month later, we received a $1,200 check in the mail from our last bank for the difference in pay-0ff amount. Basically, over the course of the entire refinance process (which took just over 2 months to complete), we'd made another 2 mortgage payments, and therefore the loan amount we secured from Bank of America was actually more than what was needed to pay it off from our original bank.
Two months of paperwork for $190k+ in savings!
Now, we've consolidated almost all our accounts with a single banking institution, which keeps things simple and convenient. And the other big benefit? When you close on a home (either for the first time or as a refinance), you get the first month's mortgage payment skipped! So we just experienced what felt like a bonus month where we didn't owe a mortgage payment on our home at all!
If you're a homeowner, I'd highly consider exploring if a refinance is right for you. Take the time to learn what your current interest rate is and ask them to tell you what your total interest payment will amount to over the course of your loan.
If you're able to afford a slight increase in your mortgage payments, explore reducing the term of your mortgage. If not, you can still save big by refinancing if the interest rate you currently have is at least 1% higher than what you can get now, and your monthly mortgage payments are likely to decrease as well.
Don't get me wrong: it takes time, energy, and effort to find out more about your options, but the savings over time can be enormous. And keep in mind, even if you don't refinance right now opting to make extra mortgage payments to pay off the principal owed on your home is always an option, and can reduce the overall interest you'll pay the bank over time.
I'm no financial advisor (in fact, I'm a client of my own personal financial advisor, Cris Caruso, who I highly recommend), so I recommend talking to someone about your own personal financial situation for the best possible advice for you. For instance, if you have way-higher-interest loans you owe (like credit card debt), your energy might be best focused on paying those down first.
But if refinancing sounds like an option you'd like to consider, don't delay. The recent rate drop from the Fed last week triggered some banks to reduce their interest rates again, too, and it's hard to imagine them them getting much lower.
Got questions? Other personal finance topics you want?
I'm all ears! Weigh in via the comments below and I'd love to share more about our experience getting our financial sh*t together this year! :)
Put your money where your heart is.