Don't Refinance Your Mortgage Without Reading This First

As news intensified over the summer that the U.S. economy was looking weaker, it caused mortgage rates to decline. The yield on a 30-year fixed rate mortgage in late August was 3.55%, a sharp decrease from last fall when the rate was near 5%.

That has set off a surge in homeowners who are eager to refinance their mortgage into a lower-rate loan. That may be practical for many of you who weren’t eligible to refinance five or six years ago when rates were rock bottom if your home’s value was still down from the fallout of the housing and financial meltdown.

Home values have been rising strongly in many parts of the country, and I imagine many of you who didn’t have enough equity to refinance in the past decade will now qualify. Or perhaps your household finances have improved enough to qualify you for a low-rate refinance; a higher credit score can make all the difference.

If you are eyeing refinance right now you better listen to me first. It makes me so crazy how most homeowners make a huge mistake when they refinance.

The big mistake is that after spending years paying down their existing 30-year mortgage, people then refinance into a new 30-year mortgage. This is so very wrong. Let’s say you have been paying your original mortgage for 14 years. Now you decide to refinance and you take out a fresh 30-year mortgage. Sure, the new mortgage is at a lower interest rate, but you just extended your mortgage-payment on this home to 44 years! That’s 44 years of interest payments.

My rule of refinancing is that you are to never extend your total payback period past 30 years. So in this example where you have already made payments for 14 years, if you refinance, you better make it a priority to get the loan paid off in 16 years. Otherwise, even with the lower interest rate on the new loan, chances are high that your total interest payments over the life of both loans will be more than the interest if you just stuck with your current mortgage and paid it off in 30 years.

If your target payback period is 15 years please ask for a 15-year mortgage. The interest rate will be even lower than a 30-year mortgage.

If you need a different length, you will likely need to take out a 30-year or a 15-year; lenders aren’t typically keen on coughing up customized mortgages such as a 24-year or 18-year mortgage.

That’s okay. What they will do for you is provide an “amortization schedule” that will tell you how much your monthly payments will need to be to pay off your new mortgage faster. For instance, if you have already paid 6 years on a mortgage, you need a 24-year mortgage. You can apply for a 30-year and ask for an amortization schedule that will show you how much your monthly payments need to be to have the loan paid back in 24 years. If you can afford that higher payment—and you promise to stick to the faster payback schedule – you have my permission to refinance.