Dear Chuck,

With interest rates so low, should we refinance our house? We bought it in 2014 for $220,000. We put 10% down and still pay PMI. We think it is worth $240,000 now. We also have some troubling credit card debt we want to pay off in the refi. 

Refi Now? 

Dear Refi Now, 

Many people are asking the same question for a variety of reasons. Some want the historically low rate; others need a lower monthly payment by getting a longer term on their loan; others want to take some equity out of their home. 

I hate for anyone to pay private mortgage insurance (PMI). Rates for this insurance can range from 0.15% to 2.5% of your loan amount depending on your credit score. Conventional loans require 20% down to avoid it. Since you paid $22,000 down in 2014 and would likely have another $18,000 in equity if your appraisal is correct, you could probably get rid of it in a refinance. 

I also think it is a bad idea to use debt to pay off other debt. More about that later. 

While it seems like a no-brainer to go for it, it is not. Plus, since I don’t have all the numbers or a full financial picture of where you are right now, I’ll offer some pros and cons for you to consider before making your decision.

Current Real Estate Trends  

Home purchase applications are up. Some analysts believe buyers are fleeing cramped urban apartments and heading to suburbs with backyards and space for home offices. Refinance applications fell 0.29% last week but are still 176% higher than a year ago. Joel Kan, a Mortgage Bankers Association economist, said that conventional refinance applications rose 2% and government refinancing applications were down nearly 7%.

Since more interest is paid in the early years of a mortgage, refinancing a home early can be helpful. Keep in mind the difference between refinancing and recasting a mortgage. A couple factors to consider are the number of years you plan to keep the house, and if there’s a penalty for early payoff. To reduce the total cost of your home (principal + interest), your goal is to pay off the mortgage as quickly as you can.

Pros

• Lowers the interest rate
• Reduces the length of the loan
• Moves to a fixed-rate mortgage
• Removes PMI payments 

Cons

• Cost of refinancing
• Cost of term lengths
• Adjustable rate mortgage

You may face the same costs you paid in your original mortgage: origination fees, title insurance, appraisal, application and closing fees. These can be covered three ways: with cash, by accepting a higher interest rate for a “no-fees, no-costs” loan, or by adding the costs to the total loan (which I do not recommend, by the way). 

Is Refinancing Worth the Cost? 

First, determine your breakeven point. This is the length of time that savings (with a lower rate) will exceed your closing costs. The calculation is found by dividing total closing costs by monthly savings. For example: a $6,000 cost divided by $250 monthly savings will take 24 months to breakeven. If your income is stable and you plan to stay in your home more than that time, refinancing can be justified. 

Short-term mortgages mean lower rates but higher monthly payments. A lot of flexibility is forfeited with higher overhead. 

Longer terms equal lower monthly cost but higher overall cost. This can be justified if you plan to make extra payments over the course of the loan.

If (and when) rates rise, a fixed rate will prevent higher payments.

Generally, I recommend refinancing if you plan to stay 5-7 years. If you desire to eliminate the mortgage faster, make extra payments on your existing mortgage. If you have no other loans against your home, you may be able to eliminate PMI. Ask your lender how you can cease this additional payment without refinancing. 

Do your math and factor in your overall financial condition. Our refinancing calculator may help you with your decision. If refinancing is beneficial, then get several quotes, including credit unions. Just do not overextend. More than 4.1 million homeowners are in forbearance plans, meaning borrowers can skip or make reduced payments. The rates for 15-year mortgages are lower than those for 30 years. Just make sure you have the ability to make those higher payments so you can avoid financial stress in the future.

Managing Your Finances 

The overall picture that you paint in your question concerns me. You stretched to get into your home in 2014 and you are carrying expensive credit card debt. My guess is you likely have some other financial practices that are preventing you from being totally financially free.

One of the best things you can do is work towards eliminating your credit card debt once and for all. Set up a plan to do that using our Debt Snowball Method. If you feel you need help, Christian Credit Counselors is the group I recommend. They can help you with any challenges you are having paying off your credit cards. 

Next, you need to be sure you have emergency funds set aside. A funded emergency savings account of 3-6 months is highly recommended. This will improve your credit score, give you more funds for refinancing costs and keep you out of financial danger in the short and long term.

Seek wise counsel from several sources. It will benefit you now and in the long run. Proverbs 1:5 says A wise man will hear and increase in learning, and a man of understanding will acquire wise counsel (NASB).

Bottom Line 

If you can get rid of the credit card debt, improve your savings and eliminate the PMI by talking to your lender, you may not need to refinance your mortgage. In most cases, it is best to use the money you save by not refinancing to pay down your principal and make extra payments as you are able. 

This article was originally posted on The Christian Post, May 29, 2020.