Beware the fees and penalties!
Sometimes it makes sense to refinance a mortgage – and it’s tempting if your rate is higher than prevailing rates – but mostly it doesn’t. It would make sense only if you have a longer-term mortgage at an interest rate considerably higher than what’s on offer at current low rates. It all boils down to the math, and like it or not, you’ll have to do some number-crunching to determine whether refinancing makes sense for you.
Penalties. You will pay a penalty for prepaying your current mortgage before term. The penalty for most closed, fixed-rate mortgages is typically either a straight three months’ interest or what’s called the “interest rate differential” penalty (IRD). The IRD is the difference between your original mortgage rate and the rate that the lender can charge today on lending the funds out again. Refinancing a variable-rate mortgage incurs a straight three-month interest penalty.
Legal fees. For many mortgagors looking to refinance, the legal bill may come as a surprise. However, remember that any change in financing on your home must be listed on the title to your property, and this change must be done by a lawyer. Those costs can add up. For larger mortgages, the lender may often absorb the legal costs in a refinancing, but this depends on the lender and whether you have a good previous relationship.
Number-crunching. Once you’ve calculated the costs of refinancing, including the interest penalty and legal fees, you’ll have to compare whether the interest payments you save by refinancing add up to more than the combined penalties and fees you’ll pay for a mortgage of the same term. If you have only a short time left on the term of your mortgage, it probably doesn’t make sense to refinance – you’ll pay more in costs than you’ll save in interest.
If you have a longer-term mortgage, look at a difference in rates between your current mortgage and your proposed refinancing. A difference of more than one percentage point over, say, a 10-year term may be worth the effort, depending on the size of your principal, of course.
Remember that mortgages are not credit cards. They are complicated debt instruments with strict financial and legal obligations on you. Sometimes refinancing at a lower rate can make financial sense – but there are no easy answers. It boils down to dollars and cents and whether the savings materially outweigh the costs. If you’re in doubt about whether a refinancing makes sense for you, check with a financial advisor, who will let you know whether a refinancing would be financially beneficial in the context of your overall financial plan.
© 2016 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.
