In this article, we’ll be discussing two common mistakes that you want to avoid when refinancing your mortgage.
The 30-year mortgage rate currently stands at 3.04% which is an all-time low. This is the lowest it’s been since 1971, when Freddie Mac started recording the 30-year mortgage rates. To give you an idea of how low that is, consider that back in the 1990s, you would have been lucky to get a 7.00% interest rate.
Exhibit 1: 30-Year Fixed Rate Mortgage
From 1971 to 2020
Source: Freddie Mac
Exhibit 2: Average Fixed Rate Mortgage
From April 2020 to April 2021
Source: Freddie Mac
As a result, there’s naturally a lot of interest in refinancing right now. Here at District Capital, we’ve helped several clients through the refinancing process, whether it be helping them decide whether or not it makes sense to refinance, or how best to do it. Thus today, I wanted to share some of my thoughts around the most common mistakes that people make when refinancing their mortgage.
Back in March of 2020, you might have heard that the old mortgage market was seizing up. What this essentially means is that in March, when investors were selling securities left and right, they were also selling mortgage-backed securities (“MBS”), leading to an oversupply of these securities and rapid declines in their value.
By way of context, when a mortgage lender gives you a mortgage, they’ll loan you the money and then typically, they’ll package that loan and sell it to an investor like a private investor, a hedge fund, Freddie Mac, Fannie Mae, etc. However in March, nobody wanted to buy these mortgage-backed securities anymore, so there was a glut of MBS in the market. However, the Federal Reserve Bank stepped in and they started buying billions of MBS, and this has helped stabilize the system.
Pitfall #1: Don’t Restart The Clock (To A Full 30 Years)
Now let’s talk about two common pitfalls. The first mistake that you want to avoid when refinancing your mortgage is don’t restart the clock to a full 30 years.
This means that if you’re already five years into your mortgage, you don’t want to extend your mortgage and pay over a period of 30 years, when you would have just paid over a remaining period of 25 years. If you restart the clock to a full 30 years, you’ll end up paying significantly more money in interest.
As a result, in this scenario you might want to request that your lender amortize the newly refinanced mortgage over 25 years.
Pitfall #2: Don’t Pay Too Much in Closing Costs
The second mistake that you want to avoid when refinancing your mortgage is paying too much in closing costs. I’ve seen lenders charge as little as $2,800 and even $2,100, and as much as $5,000 and $6,000, all over the last several months.
Naturally you’ll need to factor in the quality of their customer service and whether they have the ability to customize the loan according to your needs. However here at District Capital Management, we typically connect our clients to mortgage lenders that we’ve known for years, whom we both (a) know to be reasonably priced and (b) know will take good care of our clients.
Here’s some quick math that you can do to help you decide whether or not it’s worth paying several thousand dollars in closing costs. Let’s say that with the lower rate that you’re being quoted, you would save $200 per month on your mortgage payments. If the lender is charging you $3,000 in closing costs, divide $3,000 by your per-month savings, which in this case is $200. $3,000 divided by $200 is 15. This means that it’ll take you 15 months to recoup — or break even on — that closing cost. If you’re planning to stay in that property for significantly longer than that, then it’s a good deal.
In summary, when refinancing your mortgage, you don’t really want to restart the clock to a full 30 years and you don’t want to pay too much in closing costs. If you would like assistance, whether it’s throughout the mortgage refinance process or deciding whether refinancing your mortgage is right for you, you’re welcome to reach out to us. Schedule a free discovery call with us. Until next time!
Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help middle-class professionals achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.