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Did you know that just because you might be getting a lower interest rate on your home loan, you won’t necessarily be saving money in the long run?
When mortgage interest rates fall, many homeowners refinance to take advantage of the opportunity to lower their mortgage payments, save on interest expenses, and pay off their homes more quickly. Though refinancing for a lower interest rate is generally a good financial move for most borrowers, there are some scenarios where a lower rate does not necessarily mean a new loan is beneficial. A home loan is much more than just an interest rate, therefore it is vital to look at the entire picture, not just the interest rate, when evaluating the merits of a new home loan. This is where mortgage planning comes in.
A Lower Rate Doesn’t Necessarily Make It a Better Loan
Consider John, a fictitious mortgage borrower, who wants to refinance the 30-year fixed loan at 6% he’s had for 5 years into a new 30-year fixed loan at 5%. John does not wish to cash out equity nor set up an escrow account for his taxes and insurance, and he expects to pay third-party closing costs plus 1 point (equal to 1% of the loan amount) for the 5% rate. The payoff for his existing loan is $231,748.50, therefore his new loan, with closing costs included, will be $237,300.
The following is a summary of the assumptions this scenario uses:
| Original loan amount 5 years ago: | $250,000.00 |
| Current payoff balance: | $231,478.50 |
| Cash out? | No |
| Escrows for taxes and insurance? | No |
| Closing costs: | 1 Point + $3,500 in 3rd Party Closing Costs |
| New Loan Amount: | $237,500 |
The big question is, does the new loan at 5% actually save John money? After all, he’s getting a 1% rate reduction and a lower payment, right? Many cite the “1% rule” as a general rule of thumb to determine if it makes sense to refinance. In other words, if you can drop your rate at least 1%, it makes sense to refinance, right? Not necessarily!
Now, if John continues to pay his existing 30-year fixed loan at 6% until paid off, he will incur another $217,027.00 in interest charges. If he chooses to refinance into a new 30-year fixed at 5%, his total interest bill would be $221,289.71 – an increase of over $4000 versus his current loan! Despite the lower rate and payment, John loses in the end!
Again, just because you might be getting a lower interest rate doesn’t mean you’re necessarily getting a better loan. It’s important to review your current financial situation, flesh out your financial goals, explore your loan options, and look at the complete picture – not just the interest rate – to make sure the loan you’re getting truly benefits you in the long run.
Mortgage Planning: Just Another Part of My Great Service to You
It’s important to understand that a mortgage loan is much more than just an interest rate. If you are in the market for a new home loan, you need to work with a loan expert that can show you the entire picture when offering you new loan options and determine what will truly benefit you and help you reach your financial goals in the long run. Many lenders just take an application and quote you a few rates and figure their job is done. I recognize that a loan is more than just a rate and take pride in doing the legwork to make sure that a new home loan truly fits your financial goals and situation and keeps more money in your pocket in the long run.
This is what mortgage planning is all about, and it’s just another part of the great service I provide to all of my mortgage clients.
If you would like to read about the scenario above in more detail, feel free to check my blog post about mortgage planning.
