“Refinance” always sounded like one of those big, formal words reserved for our parents. As first-time homeowners with just three years into our first mortgage, we were initially skeptical about all the chatter around low rates. But after talking with my dad, consulting our loan officer, and reading practical blogs, we decided to investigate refinancing and see if it made sense for us. After all, who wouldn’t welcome a lower mortgage payment?
At first glance we didn’t seem like ideal candidates. We’re young, which often means a higher chance of moving, we’d lived in our home only three years so the principal hadn’t dropped much, and we originally locked in a fairly low rate of 5.75% back in ’06. Those factors made refinancing look less appealing.
After digging deeper we realized those assumptions didn’t tell the whole story. First, we actually plan to stay in this house for at least five more years—ideally forever—so the risk of moving before recouping costs was minimal. Second, a few strategic extra payments over the years had reduced our balance to about 73% of the original loan, which pleased our loan officer and validated those extra principal payments. Third, with a strong credit profile and good timing, we qualified for a 4.35% rate—one of the lowest our closing attorney had seen. Yes, we celebrated a little when we heard that.
Those elements combined into an attractive opportunity: a significantly lower rate on a much smaller principal. Our loan officer calculated that refinancing would cut our monthly payment by $430, allowing us to recoup closing costs within roughly a year. That made the decision much easier.
One concern remained: we dislike carrying a mortgage and wanted the house paid off by age 40. Refinancing to a new 15-year loan would reset our amortization, effectively putting us back at year zero. Before refinancing, our extra payments had already reduced the remaining term to about 10.5 years, so restarting felt like a setback.
Our solution was simple and intentional. We planned to keep paying the same total monthly amount we had been paying and direct the $430 savings toward the principal each month. That optional overpayment would maintain our commitment to an accelerated payoff schedule. Based on rough amortization projections, continuing this approach should reduce the new loan term to roughly nine years and save up to $32,000 in interest. Not bad for an afternoon of paperwork.
Yes, we paid nearly $4,000 at closing, which stung at the time, but with the long-term goal in mind the move made financial sense. Factoring the closing costs into our savings, we expect to net about $28,000 by 2018—the projected interest saved minus the fee. And if money gets tight someday, we still have the flexibility to lower our monthly payment immediately by stopping the optional extra principal payments.
We’ve found refinancing worked well for us because of a combination of lower rates, a reduced principal, and a plan to keep paying aggressively toward the principal. If you’re weighing the same choice, consider your time horizon in the home, current principal relative to the original loan, closing costs, and whether you can comfortably maintain higher payments to avoid extending your payoff date.
Have any of you refinanced recently or are you thinking about it? Do you prefer shorter mortgage terms like a 15-year loan? We’d love to hear your experiences, tips, or questions.
Images courtesy of Wordle, featuring text from recent mortgage and refinance-related news articles.