Should You Refinance Your Mortgage?

Over the past couple of years we have talked to many people who have questions, like is now a good time to refinance your mortgage?

Today, I want to spend some time walking you through what it looks like to refinance your mortgages.  I’ll explain some of the important terms and how to make a good choice for you and your family. What you should be considering is, what makes the most sense for you and your family?

What is a Mortgage? 

A mortgage is really just a loan against any piece of real property. By “real property,” I mean land or a house; something constructed that is not going to move. So, a mortgage equals a loan on a house. Generally speaking, the only people that can get a mortgage are people that actually own the property itself. For renters, of course you won’t be able to get a mortgage against the property. 

One of the first things associated with mortgages is the monthly payment. This is how much we are paying the bank every month in exchange for lending us the money to purchase the property. 

What are the Interest Rates?  

Another key term is what is the interest rate that we are paying the bank? This is often somewhere between 2.5% to 5.5%. One of the most important considerations that you have to be mindful of as you are evaluating whether it makes sense to refinance is how much this interest rate might actually be. For years and years and years we have been in what is called a very low interest rate environment for the past couple years. We’ve been in ultra low interest rate environments. 

However, as 2022 has progressed, inflation has picked up and these interest rates are beginning to climb. This makes refinancing more challenging. That said, that doesn’t mean it’s for sure not a wise financial decision. Every situation is different. It is important to look through all the considerations with your financial advisor for what will make the most sense for you.

Refinance Your Mortgage Amount

As you look at the possibility of refinancing your mortgage, the next thing I consider is how much can we refinance for? One of the things we could do is we could just refinance our existing loan against our home value into a new loan.

Now why would we want to do this? If other interest rates are lower than our current interest rate, it might make sense to switch to those. The thing we have to look for is, what are the closing costs going to be for the exchange? 

If those closing costs are minimal and small, somewhere around a mark of $1,000 or $2,000 this could make sense. If we are saving at least an eighth of a point or quarter of a point over a 20 or 30 year difference, that could be something to take advantage of. 

Now, unfortunately, as we’ve seen interest rates rise, one of the things that we have to be mindful of is these closing costs. Though different loans may have the same closing cost, we may not actually be getting lower rates. We might be getting high rates or equal rates. In that case, refinancing your mortgage does not make sense.

Loan-to-Value 

But what happens if, as we have seen this year, housing prices go way up? This is something which has been at the forefront of ours and our clients minds lately. 

Let’s say we had a loan on a home that was $150,000 and our home used to be worth $250,000, but now that home is worth $400,000. One of the important considerations here is that $150,000 on a $250,000 home represents a 60% loan to the value of the home. This is what is called a Loan To Value, or LTV. 

Generally speaking a bank will only lend up to 80% for a loan value. If the home that was maybe $200,000, we paid an encroachment on that loan value. This is something to be mindful of because the bank is not going to continue lending us more money. That is, unless the home value goes up significantly as well. 

As we saw in the example, our home value isn’t $250,00 anymore. It’s now $400,000. This makes the LTV 38% of our home value. Now, we have a lot more room associated with our loan to the value of the home. How much will the bank be willing to lend us? We mentioned before that they would be willing to lend us, generally, about 80%. So 80% of $400,000 is $320,000. If we consider that from 320,000 we have already been loaned 150,000, we are left with another $170,000. This leave a lot more room to take a loan out. 

Considering Interest Rates  

Now this is what we consider a cash out refinance. In other words, we would be taking cash out of the value of our home, if it made sense for us to do that. When we look at a cash out refinancing, the things we need to think about what the interest rate is going to be? Interest rates of 5% to 6% are quite common. 

This rate could be significantly higher than your current interest rate. And because we are taking out a higher loan, our payment will also be going up. So we need to be mindful of this from a cash flow perspective, from a financial planning perspective, and family perspective. Do you want to load up on debt in your home? Or are there other alternatives we can look at instead? 

When Should You Refinance Your Mortgage?

Let’s say we are looking to build out an addition on the home or a significant kitchen remodel. This is where cash out refinancing might make sense. Even at 5.5%, that interest rate is likely lower than a credit card or maybe a HELOC. 

This is another term we haven’t talked about. A HELOC is a Home Equity Line Of Credit. Think of it as a credit card against your home’s value. While a HELOC’s interest rate is, generally speaking, not a lot, it is a variable rate. It will change as market rates go up and down. That is where a cash out refinance might actually make a lot more sense. If we do the cash out refinancing, with a fixed rate mortgage, we know what we have locked in at whatever interest rate for however long we have the mortgage, whether that’s 20 years, 30 years, or anytime in between. Those are our options if we want to take advantage of home improvement. 

What if instead, we just want some extra spending money or maybe we’ve been wanting to go on a vacation? Another thing to be mindful of is, generally speaking, interest rates that we pay on a mortgage are tax deductible.

This means if we itemize our taxes, we can include the interest we pay on any mortgage so long as it is directly related to the purchase or the improvement of a home. Now, if we instead took these funds and went on a Disney vacation or set aside extra funds for spending, that would not be tax deductible. Your record keeping will be significantly more challenging because some of that mortgage might still be deductible, but some of it may not be. 

What About Paying Off Your Mortgage? 

Now, let’s say all of this is besides the point. Instead of actually taking money out of our home and leveraging the home equity, what if we actually want to get rid of our mortgage as quickly as possible? Again, we can always look at refinancing. We can refinance to a shorter time frame if needed but we need to keep in mind our closing costs of maybe higher than $2,000. 

If we have a low interest rate, what can we do? Well, we always can pay it down early! There is nothing stopping you from treating your 30 year mortgage like a 15 year mortgage. Maybe your payment is $3,500 a month. What if we make payments of $4,000 a month? We can run an analysis of how much more quickly could we pay down our $150,000 mortgage. That’s not only going to save on cash flow but will also significantly affect interest rates. Because we are making extra principal payments, we now have a less principled balance that we are being charged interest rates on. That is if we are looking to reduce our debt load. 

Next Steps With Refinancing Your Mortgage

That’s a quick run through of many things associated with refinancing, mortgages, and what might make sense for you and your family.