PFT #95 - Personal Finance Tip of the Week: The Mortgage Refinance Double Trap

In times of high interest rate environments, most people will not refinance due to the cost. With that being said, circumstances arise to warrant this, such as divorce, marriage or a job relocation.
For the most part, people wait for the federal reserve to cut rates so that borrowing money is more palatable. For example, at the time of this recording, the average interest rate for a 30-year mortgage is 7%.

So when the rates begin to drop later this year, people will rush in to refinance.
For example, a 7% interest rate for a $300,000 mortgage generates a monthly payment of $1,995. If we go to 6%, the payment is $1,798 and at 5% it is $1,610. 

So this is why refinancing makes sense; however, this comes with a caveat. When crunching numbers, the cost is between 2-6% of the mortgage amount depending on items including loan size, the type of loan and credit score.  

For our $300,000 loan at a 3% cost, this would be $9,000 bringing the total to $309,000 and this is where caveat #1 comes in: it takes approximately 7 years to pay off the cost for refinancing; however, when stretching out payments for a new 30-year cycle with a reduced interest rate, the new monthly payment is lower than the original monthly payment and people are attracted to that eye candy. 

Now in truth, a 1%+ interest rate deduction is almost always a good move if the cost is right. What you have to watch for is refinancing again when rates continue to decline. 

For example, if you refinance from 7% to 6% and then say at 5.25% and 4.25%, you may run into paying more money with the cost to refinance and accumulated interest. 

As we said a moment ago, a $300,000 mortgage costs between 2-6% or $6,000 to $18,000. If you refinance three times, that ranges from $18,000 to $54,000; and this where the second caveat comes in. 

All that money you spent to have a lower monthly payment adds up and even though your monthly payment is lower, each time you refinance, a new 30-year mortgage cycle begins. What you are doing is stretching out more cost and interest over a longer period of time.   

To sum things up, refinancing makes sense when you actually save money over a long period of time meaning you are not refinancing for the sake of refinancing and not multiple times. It is understandable that pinpointing the correct time to refinance can be challenging; however, if the market trend is moving downward, it tends to stay that way for several months and this can aid in determining when to make your move. 
 
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Episode Transcript

(00:05):
Hello everyone, I am David andyou are listening to the Personal Finance Tip
of the Week and this week's topicis on the multiple mortgage refinanced trap.
In times of high interst rate environments, most people will not refinance due to
the cost. With that being said, circumstances do arise to warrant this,

(00:29):
such as a divorce, marriage,or a job relocation. For the most
part, people wait for the FederalReserve to cut rates so that borrowing money
is more palatable. For example,at the time of this recording, the
average interest rate for a thirty yearmortgage is seven percent, so when the
rates begin to drop later this year, people will rush into refinance. So

(00:52):
let's take a sample. If youhave a seven percent interest rate for a
three hundred thousand dollars mortgage, itgenerates a monthly payment of one nine hundred
and ninety five dollars. If yougo to six percent, the payment is
seventeen hundred and ninety eight and atfive percent it is sixteen hundred and ten
dollars. So we can see thatthe money does drop on the payment.
So this is why refinancing makes sense. However, this comes with a caveat

(01:18):
when crunching numbers, the cost isbetween two to six percent of the mortgage
amount, depending on items including loansize, a type of loan, and
credit score. So taking our threehundred thousand dollars loan will assume a three
percent cost. This would make thenumber nine thousand dollars, bringing the total
mortgage amount to three hundred and ninethousand dollars. And this is where caveat

(01:42):
number one comes in. This isbecause it takes approximately seven years to pay
out the cost for refinancing. However, when stretching out payments for a new
thirty year cycle with a reduced interestrate, the new monthly payment is lower
than the original monthly payment and peopleare attracted to that eye candy. In
most situations, a one percent interestrate deduction is almost always a good move

(02:05):
if the cost is right. Whatyou have to watch out for is refinancing
again when rates continue to decline.For example, if you refinance from seven
percent to six percent and then sayfive and ared quarter and four and a
quarter, then you may run intopaying more money with the cost to refinance
and accumulated interest in the long term. As we said a moment ago,

(02:29):
a three hundred thousand dollars mortgage costbetween two to six percent, or six
thousand to eighteen thousand dollars. Ifyou refinance three times, that ranges from
eighteen to fifty four thousand dollars.And this is where the second caveat comes
in. All that money that youspent to lower the monthly payments adds up,
and even though your monthly payment islower each time you refinance, a

(02:53):
new thirty year mortgage cycle begins.What you are doing is stretching out more
cost and interest over a longer periodof time. To sum things up,
refinancing makes sense when you actually savemoney over a long period of time,
meaning you're not refinancing for the sakeof refinancing, and not multiple times without

(03:13):
a doubt. It is very difficultto pinpoint the correct time to refinance.
However, if the market trend ismoving downward, it tends to stay that
way for several months and this canaid you in determining when to make your
move. So that will do itfor the personal finance tip of the week
until next time. I am David