Dear Chuck,

We have been our first home for three years and want to refinance to lower our mortgage payments.  Should we go with an ARM, 15 year or 30 year fixed?

Thanks,

Happy Homeowners

Dear Happy Homeowners,

There’s a hymn that goes: “This world is not my home, I’m just a passing through. My treasures are laid up somewhere beyond the blue…”

Our time here on earth is temporary. One day, we’ll leave behind our house and the things that fill it. But, in the meantime, we are to wisely steward what God has given us. Since I don’t know your overall financial picture I am going to give you lots of information about refinancing and ask you to do some math and homework to make the best decision.

Refinancing a home, the paying off one loan and replacing it with a new one, can be a smart use of funds. But, what you may not know could cost you.

Reasons to Refinance

• To lower the interest rate.
• To reduce the length of the loan.
• To move to a fixed-rate mortgage.

If you want to reduce the total cost of your home (principal + interest), then your goal is to pay off the mortgage as quickly as you can.

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 is the number of years you plan to keep the house and if there’s a penalty for early payoff.

Here are some problems to be aware of.

Cost of Borrowing

Refinancing can cost 2-6% of the loan’s principal (the amount borrowed). Remember, you have already paid these costs on your current loan. A simple rule of thumb is that a minimum savings of 1% drop in your interest rate is needed to make it worthwhile.

It will require most of the same closing costs you had in the original loan: origination fees, title insurance, appraisal, application fees and closing fees. The cost can be covered in three ways. The first and least expensive option is to pay with cash. The second, is to accept a higher interest rate for a “no-fees, no-costs” loan (you pay for it with the higher rate). The third, is to finance the cost, by adding it to the amount of the loan.

Let’s assume your closing costs are $6,000 and the interest rate is 4%. Do you have the cash to pay upfront? If not, you’ll have to accept a higher interest rate. Or you can finance the $6,000 at 4% for 30 years, you’ll pay an extra $4,312 in interest making the total cost to refinance $10,312.

Determine your breakeven point or the length of time it will take your savings from a lower rate to exceed your closing costs. It equals the total closing costs divided by monthly savings. For example: a $6,000 cost divided by $250 monthly savings will take 24 months to breakeven. If you plan to stay in your home more than 2 years, refinancing likely can be justified. We have a refinancing calculator that will help you weigh your decision and find your breakeven point.

Extending the Length

Shorter-term loans have lower mortgage rates. And, chopping off a few years may not increase your monthly payment significantly.

However, some want and need a lower monthly payment and choose to refinance at a lower interest rate.  Just remember that extending the length of your loan will cause the overall cost of your home to increase, unless you budget in extra payments when your financial situation improves.

Getting too Aggressive

A 15-year fixed-rate mortgage at lower rates is tempting. But, monthly payments are higher than 30 year loans. Flexibility is forfeited when money gets tight so emergency savings is crucial. Choosing to make extra payments may be better than refinancing especially for those with variable income.

ARM vs. Fixed Rate

I think ARMs should be avoided. With the prospect of rates continuing to rise, a fixed rate mortgage prevents higher payments because of the locked-in rate. Moving from an adjustable-rate to fixed-rate mortgage is strongly advised.

Using the Lender’s Professionals

This is a clear conflict of interest and not for your good. Choose your own appraiser, real estate attorney, survey company and any other professionals you need. Get references from those you trust.

Final Thoughts

Refinancing is simpler than taking out an original mortgage. If you can lower the mortgage payment enough to recoup your costs it can be a wise financial move but do the math and factor in the stability of your job and overall financial condition.

Some say better terms can be secured during the last half of the last month of the quarter. Especially consider the final two weeks of October and November or the first two weeks of December.

Include credit unions in your research. They pass on savings to their members whereas banks generate revenue for their investors.

Remember, “By wisdom a house is built, and by understanding it is established.” (Proverbs 24:3)

Do your research, ask God to help you make a decision that both honors him and allows you to live generously with the money He’s provided. For more practical help with your finances, download the Money Map. It’s a step-by-step guide that will help you find financial freedom and reach your goals. In fact, buying a house is one of the steps! Download your copy for free here.

Originally published on the Christian Post, October 20, 2017