With long-term interest rates recently touching new lows, homeowners are again being afforded the opportunity to refinance their mortgage loans at lower rates. Is now the time? Will refinancing improve your financial situation?
Both are excellent questions, but neither has an easy answer.
While no one knows for certain where interest rates will be next week, much less years from now, a 30-year mortgage at 3.5% or even less appears to be a great opportunity. Maybe grabbing it now will prove to be the right move. But that depends on assumptions about the future.
The decision to refinance depends on more than the loan rate. The first consideration should be how long you plan to stay in your home. You’ll likely incur transaction costs which may include points on the loan, title insurance, appraisal fees, and maybe more. The new rate will need to be low enough to offset those costs within a reasonable time.
If you move forward, make sure you have clear goals in mind. Do you want to …
- Reduce your monthly payment?
- Use your home equity to finance improvements?
- Shorten the term and pay off your mortgage faster?
- Get rid of mortgage insurance?
Refinancing may help you achieve these goals and others. The more important question is whether the goals make sense in your situation. For instance, if you refinance to a shorter term that will pay off your loan sooner, then home equity will start accounting for a bigger portion of your net worth. That can be helpful in some ways, but could also reduce your overall diversification and leave you overexposed to housing prices.
For some people, the predictable yearly mortgage interest provides a “base” tax deduction that lets them itemize and deduct other items like charitable contributions. Paying down your mortgage faster than expected can impact your tax planning.
Mortgage interest has the advantage of being tax deductible (within certain limits). Other things being equal, it’s better to pay tax-deductible interest than taxable. But other things aren’t always equal. Optimizing your personal balance sheet requires careful planning that considers multiple factors.
Sometimes the answer is easy. If you have 20 years left on a 7% mortgage, then refinancing down to 3% is likely a good idea. Usually the answer is not so obvious. You need to make the decision in light of your broader financial plan, looking at everything from tax considerations to retirement, estate and investment strategies.
Refinancing also has risks you should consider. If you use a rate and term refinance, you may extend the time needed to pay off your debt. Even though your payment goes down, you may be paying for many more years (i.e. switching from a 30-year mortgage at 5.25% with 20 years left to a 3.5 mortgage with 30 years left).
A “cash-out” refinancing where you take equity out of your home for other uses may also seem appealing. However, home values don’t always go up. You might add risk to your overall financial situation if you pull out equity and then the value of your home falls.
Helping make an informed decision is one of the services we provide for Republic Wealth Advisors clients. We can help evaluate your circumstances and give you a neutral opinion whether to pursue refinancing. If the answer is yes, we can direct you to mortgage professional whom we have found to be reliable and trustworthy.
What you don’t want to do is rush into a major financial move without considering all the possible consequences. Refinancing your home is a major decision that deserves careful thought. Republic Wealth Advisors is here to help.
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