Mortgage rates are rising. But there’s still time to refinance your mortgage if you haven’t done so already, according to Dana Anspach, CFP®, RMA®, president and founder of Sensible Money.
How might you go about deciding whether to refinance and which mortgage to choose?
At Sensible Money, the process starts with establishing your goals. Are you trying to maximize your current cash flow with the refinance, or become debt-free faster, or maximize your long-term wealth? Your goals will dictate whether to refinance and which option might be best.
In an interview, Anspach gave several examples.
In the first example, a retired couple, ages 64 and 65, had $1.5 million in savings and investments and $306,000 remaining on their mortgage. The current mortgage rate was 3.38% with 23.5 years remaining until payoff and a monthly principal and interest payment of $1,596.
The couple looked at three options:
With option one, they would refinance using a 20-year mortgage with a 2.25% interest rate. The monthly principal and interest payment would be $1,589, and would result in potential interest savings of approximately $61,000 when compared to their existing mortgage.
With option two, they would refinance using a 15-year mortgage with a 1.99% interest rate. The monthly principal and interest payment would be $1,973 and the potential interest savings would be $87,000.
And with option three, they would refinance using a 30-year mortgage with a 2.5% interest rate. The monthly principal and interest payment would be a $1,212 payment and the potential interest savings was $6,000.
If the goal was to be debt free as fast as possible, the couple would choose option two, the 15-year at 1.99%. If the goal was to maximize current cash flow, option 3, the 30-year with the lowest payment would be best. In this case, they didn’t need to maximize cash flow. And they don’t need to be debt free. They simply wanted to make a decision that would optimize their wealth. The couple chose option one, said Anspach. It reduced the term of their mortgage by 3.5 years, kept their monthly payment about the same, and lowered the total amount of money they would pay in interest by $61,000.
In the second example, a retired couple, ages 75 and 74, had $174,000 remaining on their mortgage and $2 million in financial assets. Their current mortgage rate was 4.125%, with a monthly payment of $1,174, and 18.1 years remaining on the mortgage.
With option one, they would refinance using a 30-year mortgage with a 2.5% interest rate and a monthly payment of $687. Their total interest cost would rise by $3,883. Even though the rate is lower and the payment is lower, extending the term by 11 years raises the lifetime cost. That’s why you can’t judge a refinance opportunity solely by the interest rate. Of course, they could invest the difference, and potentially earn a higher return on that monthly savings, but that would entail taking on more risk and in retirement, that isn’t what they wanted.
With option two, they would refinance to a 15-year mortgage with a 2.625% interest rate and a monthly payment of $1,170. The couple would save $32,909 in interest payments with this option.
With option three, the couple would refinance to a 10-year mortgage with an interest rate of 2.625% and a monthly payment of $1,649. The couple would save $45,561 in interest payments with this option.
The couple chose option two given that it shortened the term of their mortgage, lowered their interest expense, and kept their mortgage payment about the same.
In example three, a retired couple in their 70s with $500,000 in assets had a $60,000 mortgage with a 6% interest rate on a condo they bought to help their daughter during the Great Recession. In addition, they had a $50,000 home equity line of credit (HELOC) on their primary residence.
The couple were told they could take out a mortgage on their primary residence and use it to pay off the higher rate condo but couldn't get a lower rate by just refinancing the condo as it was categorized as an investment property. Refinancing their residence would certainly save them money, but another option is a reverse mortgage.
Their home is valued at $412,000 and based on their age and ZIP code they would likely qualify for a reverse mortgage of $150,000 which they could use to pay off both the condo and their HELOC.
And that would result in no more mortgage and HELOC payments. With a goal of maximizing current cash flow, the reverse mortgage is an attractive option.
“This is a great option if they plan to stay in the home the rest of their life, which they do,” said Anspach.
In example four, Anspach spoke of her own situation as a single professional, age 50.
She had 24 years left to pay on a mortgage with a balance of $330,000 and a monthly payment of $2,101.
Her options were to refinance 1) with a 30-year mortgage with a 2.75% interest rate, a monthly payment of $1,347, and total savings of $43,591 or 2) with a 20-year mortgage with a 2.625% interest rate, a monthly payment of $1,769, and a total savings of $104,058. She opted for the 30-year mortgage as a way to maximize cash flow that could go toward investing for retirement.
Two last notes:
Anspach recommended paying closing costs and points out of pocket and acting quickly to refinance if you haven’t already. Mortgage rates are rising from historic lows. A good place to check out current rates is Bankrate.com and a good place to evaluate whether to refinance is Zillow.com.
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