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Is Now the Time to Refinance?

In the first Godfather movie, young Michael Corleone says the famous line, “It’s not personal, Sonny.  It’s strictly business.”  Anyone who has seen the movie or been on the receiving end of this saying knows that every time it’s uttered, the situation is personal to someone.  While nearly every decision we help people make on a daily basis has some “business” root with concrete numbers to be considered, most situations are resolved based on personal values and circumstances.  Sure, the numbers have to work, but there are always trade-offs to be considered.  This is the case we’re seeing today as we’re often asked about refinancing home mortgages.  Although we’re living with historically low interest rates as shown below, the refinancing decision still has plenty of nuance and should not be made by a simple comparison of rates.

An old rule of thumb when reviewing your mortgage is to refinance if you can get a rate 1% lower than you are currently paying.  Some more conservative studies or those done in markets with higher closing costs cite 2%.  This is a mistake as we’ve yet to see a rule of thumb that can account for all the possible variables.  Instead, step one must be a break-even calculation.  If you refinance today and reduce your monthly expense by some amount, how long will it cost you to recoup the cost of refinancing?

There are plenty of online calculators that can tell you if you lower your monthly payment by $200 and pay $2,400 in fees, your break-even period is one year.  However, many of these calculators compare two loans as if they are being made the same day, which is never the case.  To make a true apples-to-apples comparison, you must adjust the term of the refinanced mortgage to match your current deal.  It doesn’t make sense to compare a new 30 year mortgage with a similarly structured loan that you’ve been making payments on for eight years, yet owners laser-focused on their monthly budget often do.  This is especially important for pre-retirees who often stand to benefit more from the flexibility of a mortgage-free retirement than from refinancing to save today.

There are also circumstances not captured by online calculators that can sway your decision.  If you made a small down payment that required private mortgage insurance (PMI) but your home value increased, a refinance may provide savings up and above what you get from a lower interest rate.  The same is true if your initial mortgage was a jumbo loan and your payments have brought a refinance under the limit.

All of these calculations help us make sure the numbers work, but don’t answer the most important question of whether or not they work well enough for you.  A break-even calculation may say there is no advantage to a refinance, but if you itemize deductions the mortgage interest deduction may change your true cost.  Conversely, a refinance may be a slam dunk long-term but not worth the opportunity cost if you have a tight budget and high interest credit card debt.  As with most decisions we help people make, the math doesn’t always tell the whole story.  In this case, the business is definitely personal.  If you have any questions, about your mortgage or otherwise, we’re always here to help you understand the options and make the best decision for you.

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