Should I refinance my home mortgage now?

Question

 I just purchased a newly built townhouse and have a fixed-rate mortgage below 4%.  Should I try and get a lower rate?

Asked by: AG – Texas
Answer

Homeownership is a good thing and homeownership with a fixed-rate mortgage is even better!  Why?  Because your payment amount is fixed forever.  Sure, taxes and insurance can increase, but the bulk of your monthly payment is principal and interest and with a fixed-rate mortgage this amount never changes for the duration of your loan. 

I'm assuming your mortgage interest rate is fixed.  A general rule of thumb is refinancing when you can gain a lower rate equal to one-half percentage point or more. So if you can get a fixed rate of 3.5% or better, it's an excellent idea to re-fi. Even better is getting a lower rate and reducing the loan term or the number of years on the mortgage.

Why one-half percent, what's the magic in that differential? Consider it a placeholder number.  There's nothing that magical about it other than it represents a measurable difference.  With a half-point change, when you see this on paper, it is a number that is meaningful, $50, $100, $200 per month in a lower mortgage payment.

Let's look at a few examples.

Example #1

Looking at the principle and interest payment only, a $200,000 mortgage with a 4% interest rate amortized over 30 years has a payment of $955.  That same $200,000 mortgage with a 3 1/2% interest rate amortized over 20 years has a payment of $1,160. 

The result between these two mortgages is that you would cut ten years off your payments for $206.00 more per month.  Said another way, $49,440 in payments ($206.00 for 240 months) saves $114,600 in mortgage payments ($955 for ten additional years past the originating 20-year term). 

The only way this outcome applies is with a fixed-rate mortgage. Trying to use the same form of logic to a variable rate loan is folly. 

Example #2

Let's take a $300,000 mortgage at a 5% interest rate representing a low loan-to-value first mortgage.  How much more could you borrow at 3 1/2%, Assuming property valuation was not an issue?  The answer is you could obtain a new mortgage for 358 thousand dollars and maintain the same payment as before.  

The Internet is filled with mortgage calculators.  Most of these calculators come with costs in that companies are capturing your information or want you to sign up for their newsletter, etc. An alternative to this is to purchase your very own Hewlett-Packard 10-B financial Calculator. 

It will take a little bit to get up to speed on how to use the HP 10-B for calculating mortgage payments with various terms, interest rates and, amounts, but the work will be worth it. Because having that tool in your hand puts you in control of generating various scenarios about your financial decisions. I highly recommend it for personal and business use.   

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