Mr. FAF and I bought our first home in early 2016.
We went from being long-time renters to home owners over night.
Though excited, we were also aware of the huge mortgage that we had gotten ourselves into to make one of our biggest dreams come true.
Mr. FAF and I are aggressively trying to pay off our mortgage. We have also thought about refinancing and whether it help us pay off our mortgage faster.
Today we have a guest post from Bernz JP. He will share with us the story of how he and his wife slashed their mortgage payment by $700 a month.
Bernz entered the entrepreneurial world by starting his first online marketing business in 1997.
He became successful with his affiliate marketing business and one day realized that the bank is not the right place for his money.
Bernz started learning how he can invest and make his money work for him.
He currently has investments in stocks and real estate.
His blog Moneylogue.com is not your typical personal finance blog.
He believes that financial knowledge alone is not enough to be successful financially.
Motivation and self-discipline combined with knowledge are the keys.
Bernz has a BA in Accountancy. He lives with his family in the suburbs of Chicago, Illinois.
Our refinancing story
I believe refinancing a mortgage is one of the best options a homeowner could have in their financial life.
In January 2001, my wife and I started shopping for a house. With two growing kids, we felt that we needed to move to a better community with a better school system.
Six months later, in July 2001, we found and bought a place we still call home to this day. After the purchase, the housing prices in our area (Chicagoland) started to skyrocket, which made us ecstatic.
In 2011, three years after the 2008 global financial crisis, we decided to refinance our home to a much lower interest rate. Our initial interest rate was 8%, and mortgage companies and banks were offering an average of 5.5%. We took that 5.5% deal.
Although we opted for the same 30-year fixed term for more flexibility with our money, our mortgage payment went down by almost $500 a month.
At that time, we believed that it was the best option for our situation. We honestly thought that mortgage rates would never go lower than 5%. We were wrong!
Mortgage rates just kept declining. In 2012, we decided that refinancing might not be a bad idea once again. This time, we went from a 5.5% interest rate to 4.75%. This again lowered our monthly payment by almost $200. We were happy campers once again.
In total, refinancing our mortgage from 8% to 4.75% slashed our mortgage payment by $700 a month.
Now, I’d like to point out that we were not the only winners in this game of homeownership and refinancing. Quite possibly, banks and other lending institutions came out as big winners as well. Hey, it’s more business for them.
The benefits of refinancing
Tax deduction is simply a tool used by the federal government to encourage home ownership and more lending in the US. We are a credit-driven economy.
On any mortgage note, most of the interest is always paid during the first part of the loan period (around 18 years of the 30 years). After that, more of your payment goes to principal reduction rather than interest payment.
For a typical 30-year loan of $300,000 at a 4% interest rate, you would have paid $215,609 in interest plus the principal or a total of roughly $515,609 plus tax and upkeep of your house over those 30 years.
Let’s say that 5 years into this mortgage you decide to refinance at 3% on a 15-year mortgage. Now you have already paid about $85,920 for living in this home for 5 years. Your payment for the first 5 years of $85,920 plus your total payment after 15 years of $372,914 are now at $458,834 after 20 years. You saved over $50,000 and 10 years.
If you refinanced at the same 4% rate for 15 years, your payment for the first 5 years of $85,920 plus your total payments after 15 years of $399,431 are now $485,351 over 20 years. You saved over $30,000 and 10 years.
Financing and refinancing can save you money but typically only if the interest rate is lower and if the term is shorter.
You may be wondering about adjustable rate mortgages (ARMs) as an option. One never knows when the rate will go higher. And in today’s low-interest rate environment, interest rates have nowhere to go but up.
Assessing your situation
The purpose of the above discussion is to simply show you the math involved. However, there are other factors you need to take account of:
— How long do you plan to keep the house?
— What if a job opportunity requires relocation and you have to sell your house before you relocate?
— Will the refinancing place your house upside down after a housing market downturn?
To put everything into perspective, let’s set some ground rules on refinancing your house.
— Only refinance if you can get at least 2 percentage points better than your current interest rate.
— Would simply adding that extra payment or two per year to the principal put you in a better situation than refinancing?
— Consider a shorter term on the loan if refinancing.
— Always make sure that you are at least 90% loan to value. 80% is better to avoid private mortgage insurance (PMI). This is to buffer against a market downturn. Never take the lender’s option to get a 125% loan against the value of your house.
— Always consider your long term goals. Where do you wish to live 10 years from now? Do you truly wish to own the home or simply keep making mortgage payments for tax deduction purposes?
— In 3 years when you are able to retire to a new location or even pass away, is it important that your heirs own the home? Oftentimes in our society, the adult offspring do not even want the house they grew up in.
For you to be a prudent borrower against your own home, you may want to ask yourself some more questions about the marketing practices of the lenders.
When I am online, I get a lot of pop-up advertisements from loan originators and lenders. Their most recent ploy is to tell you why switching to a 15-year mortgage is now your best option. One might wonder why they are promoting this tactic.
Loan originator companies make money doing loans. However, the loan originators make money on “originating loans that close.”
If a lot of homeowners are in 30-year mortgages, an easy way to recycle new loans is to get people already in home loans to do it again. Of course, the promotion is always about new government regulations and programs.
Here is the main issue that you need to fully and completely understand. You need to serve you and your interests first. By simply looking at your own situation and checking the suggestions above, you will be able to figure out the best course of action for you and your family.
Read and learn or talk to a friend in the banking or mortgage industry to get more information about refinancing options and whether they work for you.
When it comes to our home mortgage, one of the biggest and most important expenses in our lives, you will want to ask yourself the following questions: Whose future is it? Whose hard earned money is going to pay the loan down? Certainly not the loan originator!
Take the time to do your homework and objectively assess your own situation. It is that important. Do not set yourself up for failure years down the road when the fancy loan promotion has long since disappeared and some new loan promotion is now being advertised.
This is an open-ended and extremely subjective question as the answer lies in each and every homeowner’s particular situation. There is no one-size-fits-all solution. Simply chasing lower interest rates by refinancing every few years may not actually help you achieve your short-term or long-term goals.
In our case, my wife and I decided to refinance simply because the new rates were lower by 2.5% and later on 0.75%. It fortunately worked out well for us and helped us lower our mortgage payment by $700 a month.
The main goal of this article is to help you think through the issues of refinancing. It is not always a good idea to simply jump into another new mortgage because a loan originator told you that you qualify under the new guidelines.
Bernz can be contacted on his blog Moneylogue.com.
What about you? Are you thinking of refinancing your mortgage? What’s holding you back?
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