If you have a mortgage, refinancing might be an option. When you refinance a mortgage, you replace your existing mortgage with a new one. In today’s topsy-turvy world, people are always looking to score a better deal.
There’s no need to feel bad about it – the cost savings can be dramatic; a small fortune over the long-term. It’s true that many homeowners seek basic rate-and-term reductions since lower interest rates over a compressed period translate into bigger savings.
Homeowners with specific eligibility can leverage specialized programs. As a case in point, a qualified homeowner may use a VA cash out refinance to lower their interest rate and to tap into their home’s value.
These types of cash out refinancing solutions allow eligible veterans to leverage up to 100% of their home’s value. The funds can be used for debt consolidation, renovations, or bucket list items. This is particularly relevant when the Fed slashes interest rates.
Here’s What A Rate Cut Looks Like Practically
| Metric | Original (5%) | New Loan (4%) | Difference |
|---|---|---|---|
| Monthly Payment (P&I) | $1,610.46 | $1,432.25 | $178.21 saved/month |
| Annual Interest Expense | ~$14,900* | ~$11,900* | ~$3,000 saved/year |
| Total Interest Paid | $279,767 | $215,610 | $64,157 saved total |
Let’s take a hypothetical example to drive the point home. You may wish to consider refinancing your mortgage if your original $300,000 mortgage was locked in at 5%, but the interest rate has dropped to 4%.
Any number of reasons can precipitate interest rate movements and you’re probably familiar with these cyclical movements. When the Fed cuts rates, it’s usually because the economy needs stimulation.
In other words, to speed up the velocity flow of money. If there is rampant demand, rates may rise to reign in an overheated economy to prevent inflation.
There is a natural correlation between the direction of Fed policy with bank rates and interest rates. Although, to be fair it’s certainly not an exact match.
Lenders typically wait for macroeconomic policy to filter down to the housing market and determine rates based on demand and supply considerations, liquidity considerations and capacity too.
Overall, Fed rates and mortgage rates tend to move in the same direction, albeit to different degrees.
What Experts Recommend Leveraging New Mortgage Options
Opportunity wasted is expense incurred. In the real estate industry, small interest rate movements translate into outsized savings or expenses. When interest rates trend lower, it may be worthwhile refinancing a mortgage.
Of course, there are fees, commissions, or related costs to consider. Most of these are rolled over into the refinanced mortgage at the new rate.
Many homeowners refinance when mortgage rates drop, but it’s also possible to refinance when they rise slightly, if you want to get cash out.
This brings us to an important concept: equity. In real estate parlance, equity is synonymous with owner’s share. Now’s a good time to extrapolate from the earlier example with a $300,000 mortgage at 5%.
If interest rates drop to 4%, refinancing sounds like a good idea. Let’s assume the owner held the mortgage for ten years and managed to pay down $50,000 of the mortgage, with an initial down payment of $30,000. If the market price of the property is $400,000, we can calculate the owner’s equity.
Equity is the difference between the current market value of the property and the remaining mortgage balance. In this case, the owner put down $30,000 and paid off $50,000 of the mortgage.
The remaining mortgage is $250,000 and the market price is $400,000. The owner’s equity amounts to $150,000. That’s much higher than the $80,000 already paid. The balance of $70,000 is known as unrealized appreciation.
Diving Deeper Into The Break-even Point And Use Of Funds
Long before you sign on the dotted line to get approved for a new mortgage at a lower rate, use a mortgage calculator. These tools can help you determine the break-even point.
Recall, there may be fees associated with refinancing your mortgage. These rolling fees are worked into the new mortgage and they preserve your immediate cash flow.
But you still have to pay them back over the long-term. The way experts calculate the cost of a refinance is by evaluating the monthly savings versus the costs of refinancing.
In our example, the monthly savings amount to $178. But if the closing costs are $5,000, it’s going to take 28 months to break even. If you plan to sell the property or move within two years, it’s not worth your while.
If you plan to stay for longer, it may be. What you do with your money is your business, but it’s always best to make your money work for you, not against you.
Home renovations can be beneficial and generate a return on investment. A once in a lifetime vacation certainly adds value to the quality of your life, but not as an ROI accounting entry.
Refinancing a mortgage can be beneficial, provided you perform due diligence. Always try to understand the implications of lower interest rates and extended terms. Use your money wisely and be sure to access all available resources at your disposal.
