Suze Orman says avoid this 'huge mistake' when refinancing your mortgage
Suze Orman says avoid making "big mistakes" when refinancing your mortgage
With the lowest mortgage rates ever this year, homeowners have refinanced their loans and cut their monthly payments, often by hundreds of dollars.
If you're thinking of joining the onslaught on Refi, personal finance writer and television personality Suze Orman wants you to stop and take a deep breath - so you don't botch it up.
"It drives me so crazy how most homeowners make huge mistakes when they refinance," she says.
It's a flaw that Orman says can easily saddle you with much higher interest costs even if you manage to get a mortgage rate that your friends will envy.
"So very wrong"
Mortgage rates have fallen to new lows in 2020 as the coronavirus crisis rocked investors and led the Fed to cut interest rates close to zero to prop up the economy.
In this year's quarter from April to June alone, low interest rates prompted nearly 1.7 million homeowners to refinance - more than twice as many as, according to Attom Data Solutions, took out new loans in the same period in 2019.
According to Orman, the costly mistake most of the youngest refinancers likely made was automatically reaching for another 30-year mortgage, even if they had paid off their existing 30-year loan for several years.
"This is so very wrong," she writes on her blog.
The personal finance guru says you paid back your original loan for 14 years and then took out a new 30 year mortgage. "Sure, the new mortgage has a lower interest rate, but you've just extended your mortgage on this house to 44 years!" She says.
When a 30 year refinancing could make sense
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The 30-year fixed-rate mortgage is America's most popular home loan, so it's obviously the go-to stop for homeowners looking to exchange their existing mortgages for a better rate.
And it's the obvious choice if your current mortgage is fairly new. Millions of people who financed their homes in early 2020 - when 30-year mortgages averaged 3.75% - could save an average of $ 299 by refinancing at today's low interest rates, mortgage data firm Black Knight has estimated.
However, like many experts, Orman generally recommends refinancing a new loan with a shorter term.
"My refinancing rule is that you must never extend your entire payback period beyond 30 years," she says on the blog.
Let's say you are actually holding onto a 30-year loan that you took out 14 years ago in the fall of 2006.
Back then, the average rate was a stiff 6.4%. (Seriously, you should have funded yourself beforehand.) Let's say your initial mortgage loan was $ 250,000. You now have about $ 188,000 in balance.
Why Consider Refinancing To A Shorter Term Loan?
30-year fixed home loan interest rates averaged just 2.87% today, according to mortgage company Freddie Mac.
If you refinance that $ 188,000 balance into a new 30 year 2.87% mortgage and kept the loan for the full term, the lifelong interest would be nearly $ 93,000.
You can opt for a 15-year refinancing instead. Mortgages with a term of 15 years have lower interest rates than loans with a term of 30 years: the average for a term of 15 years is currently only 2.37%.
On a 15 year mortgage of $ 188,000 at 2.37%, you would pay just under $ 35,600 in interest over the life of the loan. That's $ 57,400 less than the 30 year refinance.
However, many refinancers don't opt for a 15 year loan because they don't believe they can afford the higher payments:
The monthly payment (principal plus interest) for a 30 year refi of $ 188,000 at 2.87% is approximately $ 780.
The monthly payment (principal plus interest) for a 15 year refi of $ 188,000 at 2.37% is $ 1,242.
Orman said mortgage rates have been so low for 15 years over the past few years that "you may be able to refinance your remaining balance and receive a payment that is not significantly different from your 30-year payment."
And in our example it is true:
The monthly payment (principal plus interest) on the original 30 year mortgage of $ 250,000 at 6.4% was $ 1,563. The new 15 year loan costs $ 321 less per month.
How to choose
Albert H. Teich / Shutterstock
Suze Orman says don't forget about closing costs when doing your refinance math.
Whichever type of mortgage you choose to refinance, you want to be sure that you will be staying in the house for a few years.
"There is no such thing as free refinancing," Orman says. "You either pay closing costs - which can be a few percentage points of your loan cost - or a higher interest rate."
According to ClosingCorp, the average mortgage closing cost is now over $ 5,700. You won't want to move until the savings from your new, lower mortgage rate pay off your closing costs - and some more.
If you think you will be in the house for the long term, refinancing into a 15 year mortgage may be the smart choice if you can handle the payments. Your interest rate will be lower and you will pay tens of thousands of dollars less in interest over time.
Opting for another 30 year mortgage and lower monthly costs may be wiser if you are unlikely to be staying in the house long term. If you are leaving within a few years, what does it matter if you have a 30 or 15 year loan?
Before you decide on a loan, you should always look around. Get mortgage quotes from multiple lenders to find the best available interest rate in your area and for a person with your creditworthiness. Don't assume that the very first lender you met will offer you the lowest possible interest rate.
Make sure to use your comparison shopping skills when you get your renewal notification from your home insurance company as well. You can easily get multiple quotes for home insurance and compare rates to see which works best for you.
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