Low interest rates have inspired millions of homeowners to refinance-so many millions that the Mortgage Bankers Association says refinances increased an astonishing 629 percent in November 1991 compared to a year earlier.
But while mortgage rates of 8 percent and less are tempting, you should figure out for yourself whether it makes sense for you to refinance.
It`s easy enough to figure out if you have a 30-year mortgage with a 10 percent interest rate and want to trade it in for a 30-year mortgage at 8 percent. You calculate monthly savings, compare that to closing costs and see how long it would take you to recoup those costs.
But what if you want to refinance from a 30-year to a 15-year mortgage?
In all likelihood, your monthly payments will increase-not decrease-even if you get a lower interest rate.
The good news is that with a 15-year mortgage, the amount you are paying towards principal increases dramatically right away. That is where the savings comes in.
Here is an example, worked out by Arthur Ringwald, executive vice president of Sears Mortgage Corp, headquartered in Riverwoods, Ill.
Sample savings
Say you have a $100,000, 30-year mortgage with a 10 percent interest rate. Your monthly principal and interest payments are $877. Initially, $833 of that is interest and only $44 goes to paying off principal.
Right now you could refinance to a 15-year mortgage at a rate of 8 1/8 percent with no points. Your closing costs in most states would be under $1,500.
Monthly payments on the 15-year mortgage at 8 1/8 percent would be $962. Of that amount, $677 is interest and $285 is principal.
With the new 15-year mortgage, your payments have increased $85 a month. But you are building equity at the rate of $285 a month, versus $44 under your old mortgage, a ”savings” of $241 a month.
”The payback would be almost immediate,” Ringwald said.
If you have had your 30-year mortgage for some years, you will be paying more to principal and less to interest than you were during the first year. But on a 30-year mortgage, the amount paid to principal each year increases slowly. With a 15-year mortgage, the increase is more rapid.
For instance, if you are in the fifth year of a $100,000, 30-year mortgage with an interest rate of 10 percent, you are paying $9,700 in interest for the year.
By contrast, in the first year of the 15-year mortgage at 1/8 percent, your interest payments are $8,124-almost $1,600 less.
New loan boon
Jack Thompson, a sales manager with Citicorp Mortgage in St. Louis, says most people these days have a fairly new mortgage.
”The majority of loans out there now are less than 7 years old,” he said. ”We`re refinancing people we refinanced just a year ago” because of the drop in interest rates.
As you can see, the payback in a 15-year mortgage is quick.
Although it would be difficult to figure out on your own how long it would take to recoup the costs of refinancing from a 30-year to a 15-year mortgage, anyone with mortgage amortization tables can do the calculations for you-mortgage lenders, financial planners, accountants, real estate agents.
Figure out where you are in your 30-year mortgage. Ask what the closing costs will be to refinance and what rate you can get with points and without points. Ask what your monthly payments will be on a 15-year compared with your 30-year mortgage.
With these figures and standard amortization tables, you can see whether refinancing makes sense in your case.
