Caution: Refinancing with Low Mortgage Rates May Not Work

I got a letter from my mortgage lender offering to refinance my home. I could lower my rate, said the letter, and I might save money.

Actually, both claims are correct but the bigger issue is whether refinancing is actually worthwhile.

According to the letter my mortgage rate would drop from 4.63 percent to 4.46 percent if I refinance. That’s right, based on the APR or annual percentage rate, my rate would fall .17 percent. Not a partial .17 percent, not a fraction of .17 percent, but a full .17 percent. That’s about 1/6th of 1 percent.

But wait, there’s more.

And, yes, monthly costs would fall. For instance with a fixed-rate, 30-year $200,000 mortgage the monthly expense for principal and interest would go from $1,028.88 to $1,008.62. That’s a savings right there of $20.26 per month or $243.12 annually.

So the lender’s letter is literally true: I would have a lower interest rate and save almost $250 a year in this example.

Mortgage Rates

Despite the accuracy of the lender’s claims — which are subject to change along with the interest rate according to the letter — the offer is unacceptable to me. Here’s why.

How much would I have to spend at closing to save $250 a year? If closing costs $3,000 for transfer taxes, legal fees, title insurance and other expenses than it would take 12 years of mortgage “savings” to get back my money.

And why are mortgage rates at anywhere near 4.46 percent attractive in today’s world? The latest figures from Freddie Mac show that a typical 30-year mortgage is priced at 3.98 percent — that’s almost a half point lower than the offered rate.

Nope, I won’t be taking the lender’s offer.

But here’s the question: Why didn’t the lender simply repeat it’s last refinancing offer — an offer I took. In that case the rate went down almost a point, I saved about $200 a month and the lender paid all closing costs except prepaid taxes and insurance.

The lender and I both benefited. I got the lower monthly payment and the lender got a crisp, new loan to re-sell at a profit in the secondary market.

In other words, everybody won.

Mortgage Prepayments

The new refi offer doesn’t work because it’s one-sided — assuming the lender actually provides the terms mentioned in the letter (remember, they’re subject to change).

If I’m going to spend more money on a loan, I certainly would not pay $3,000 in closing costs to save $250 a year. Instead, I might simply increase the monthly payment by $25. While a $200,000 loan at 4.63 percent costs $1,028.88 per month, I might instead pay $1,053.88.

That would reduce the total interest bill over the loan term by nearly $10,000 — from $170,396.80 to $160,502.20 — and shorten the mortgage term by 18 months. This approach works regardless of whether the loan is an FHA, VA, or conventional fixed-rate loan. The concept also works for fixed-rate jumbo mortgages as well.

As to the lender — hey, write me again. Let’s redo the last deal at today’s rates. You know where I live.

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