Debunking the myth: Does one really need to drop a “full percentage point” on their mortgage to see benefit?
Hi all, this is Aaron Endy. I am the Director of Marketing here at Evergreen Mortgage and in my typical day I do a lot of pre-qualification for Kjell. During my time here, I have heard many myths and downright false information about refinancing from potential clients and clients alike. While Kjell may take the position of expert on these matters, I simply wish to share what I have learned over the past year, during my time working for Kjell and Evergreen Mortgage.
The first myth that I would like to debunk, “if I don’t drop at least a full percentage point (on their mortgage interest rate), it isn’t worth my time.”
Oftentimes, I hear this when talking to a potential client who hasn’t yet seen the benefit that a refinance could have for them, and this particular idea is one of the most commonly stated. While it is always nice to slide down a full percentage point on interest rate, it isn’t the only factor, and should hardly be the deciding factor when refinancing your mortgage.
There are a lot of reasons to refinance, listed below are some of the most common.
Wrapping in credit card debt.
Paying off a 2nd mortgage or HELOC
Cashing in on your Equity to remodel a home
Getting rid of a Variable Mortgage.
Getting rid of mortgage insurance
Wrapping in Credit Card debt is a good way to pay off large balances. Credit cards typically carry an interest rate of between 10-19%. Wrapping the debt in at a lower rate can be a great way to mitigate some of the debt. Even if you don’t drop your current mortgage rate by a full percentage point, you will have drastically reduced the interest on your credit cards.
Combining mortgages is always nice, especially when the second mortgage has a high-rate fixed, a variable rate, or a HELOC with a balloon-payment. Combining these into a first mortgage can be a great way to save some money if you have the equity to do so. Your overall mortgage interest rate can be reduced, plus you’ll protect yourself against a rate increase on your 2nd mortgage.
And of course, if you have a lot of equity, why not use it to make your home more valuable? Remodeling projects are fairly common, and using equity to pay for home-improvement is a great way to fund these projects if you are low on cash. The remodel can often significantly increase the value of your home and your quality of life, even if your interest rate didn’t drop by a full percentage point.
Many people carry what is called a variable interest rate. This rate is subject to change year to year. It is typically lower than the current fixed rate, but can end up becoming a rather difficult payment to make as interest rates rise. Getting a similar fixed payment is a good reason to refinance.
If you have an FHA loan, chances are that you carry what is called mortgage insurance. This is an insurance designed not to protect you, but to protect the lender. It is essentially an extra monthly payment you make toward the loan. Removing this by refinancing into conventional loan has the possibility of dropping your effective interest rate by more than a full percentage point, even if the “note rate” is not a full percent percentage point lower.
Of course, the primary reason is usually to save more money per month. There are many variables which determine how much money a person will pay each month on their mortgage, and subsequently how much they can save through Refinancing. On one occasion, we saved an individual $120 a month by just lowering their interest rate 0.5 points. This is not too uncommon. Ultimately, if the goal is simply to save more money, one should look at the dollar signs, not the interest rate, to help them make the decision of whether or not to refinance.
Even if you are just reducing your interest rate (not consolidating debt, dropping your mortgage insurance, etc.), the savings from dropping your interest rate by even 0.5% can be substantial.
Let’s look at the numbers: Let’s say a prospective client buys a home with a mortgage of $200,000 at 4.625%. About 3 and a half years later, they consider refinancing (we’ll also assume they’re employed, have good credit, etc.). At a 4.125% interest rate, their payment would drop by $127/month, which is a full car payment. If I drop that even lower to 3.625% (a full percentage point), the rate is certainly better, but the additional monthly savings is only about $45. A 4.125% drop is not a full percentage point, but the real question is, is a monthly savings of $127 enough of a benefit?
When I look at refinance options, I typically look at how much money the individual will save. If it is over $100 then the savings are significant, anything above that would be beneficial, but ultimately that is for the individual to decide. Is this enough money in my pocket to justify refinancing?
So, the next time you are considering refinancing your mortgage, take a different approach and look at what the benefits actually look like, rather than depending upon a simple interest rate.
