My husband and I just refinanced our mortgage for the second time. We started the process back in May, so it took four months - these days, that seems to be typical. I have friends who've been in the refi process for months, too. I thought I would share our reasons, because it goes beyond straight finances, and has a lot to do with planning ahead.
First, the basics: What is a refinance? It's when you pay off the existing mortgage by taking out a new mortgage with new terms, especially a new, lower interest rate. This should lower the monthly payment. It also resets the clock - so if you had a 30-year mortgage and refinance to a new 30-year mortgage, you have another 30 years to pay it off. In order to refinance, you'll likely have to pay closing costs, which can be rolled into the new mortgage so you don't have to pay it out of pocket.
The most common reason for refinancing a mortgage is to lower payments and save money in the long run. And of course, that was a huge motivator for us. Our interest rate dropped from 4.125% to 2.875%, lowering our monthly payment by over $300.
There are calculators that will help you figure out how long you need to hold a new mortgage, but basically, you take the closing costs and divide by the amount you're now saving per month. The result is the number of months you need to hold the new mortgage to recoup the amount of the closing costs. Once you do that, the monthly savings are just that - savings.
In the case of this refi, our closing costs totaled $2,340. (We didn't have to pay almost $600 for an appraisal because the loan amount was so much less than the value of our house.) If you divide $2,340 by $300, you get 7.8 months. So after 8 months, we will pay less with our new mortgage than we would have with our old mortgage.
That makes it easy to see why people refinance - who wouldn't want to end up paying less in interest if you can?
Sometimes it takes longer to recoup the amount of the closing costs. The first time we refinanced our mortgage was back in 2010, when I quit working as an attorney and cut our income in half. If I recall correctly, we reduced our monthly payments by $200 but paid between $4,000 and $5,000 in closing costs - so it took us between 20 to 25 months to recoup the closing costs.
If we had planned on selling our house in less than two years, refinancing wouldn't have made sense because we never would have made up the closing costs. But since we knew we were staying put, I wanted that extra $200 per month for the sense of security. (I knew we could get by on just my husband's salary. But I also knew that "things happen.")
The main reason I wanted the current refi to go through is that our oldest child will be heading off to college in two years. And his brother will follow two years after that. An extra $300 per month will obviously be helpful - especially because I will probably sign up for the college's payment plan, which lets you make monthly payments instead of paying the full bill all at once at the beginning of the semester. (I don't know where my kids will go, but as far as I know, every college offers a payment plan.)
The kicker is that we've always paid extra on the mortgage to pay down the principal faster. So if we start paying just the minimum on our new mortgage, we'll actually be paying $600 less per month. That's an extra $7,200 per year to put toward college. That could end up being the difference when it comes to choosing one school and its financial aid package over another.
If you're wondering if you should refinance your own mortgage, here are a couple of questions to ask yourself:
Will you hold onto the property long enough to recoup the closing costs? Keep in mind that you can shop around for the lowest rates and lowest closing costs.
What will you do with the monthly savings? I think it's important to have a plan for the money. I've always continued paying the original mortgage amount, which means that our monthly expenses stay the same and the mortgage just gets paid down faster. However, if the boys' college costs mean we need the extra $7,200 per year, I can lower our mortgage payment to the minimum and put the difference toward college. Other ways you might plan for the savings include building your emergency fund or putting the money in a 529 plan for your child's future college expenses.
I also want to note that because it took so long to process the refi, the amount we borrowed ending up being several thousand dollars more than the total payoff of our old mortgage plus closing costs. I was told that lowering the loan amount would result in the loan being sent back to the underwriting department, which would basically start the process over again. I wasn't doing that! We ended up getting some of the extra money back as cash (even though it wasn't a cash-out refi) and some of the money was applied to the principal of the loan. I was told we couldn't avoid the cash back - I could have made an extra payment on the loan to pay down more principal, but I just put the money in savings, since the whole point of the refi was to have money available to pay for college.
It was a four-month odyssey, but it was well-worth it. I'm happy we're maximizing our ability to pay for the kids' college educations - and in my next post, I'll discuss why we're willing to pay.
(Note: Apologies if you got a notification about an old post about looking forward to March. I'm doing some housekeeping and accidentally republished a post from 2005!)
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