Downward pressure on mortgage interest rates creates financial opportunities for existing and potential homeowners. Homeowners can use refinancing to reduce mortgage payments and expedite mortgage payoff. Choosing this course of action, even in ideal market conditions, can involve complex cost considerations. Your tax professional can assist you with asking the right questions and arriving at the best financial outcome.
- Do the benefits outweigh the costs?
When you refinance, you are essentially replacing your original mortgage with a new one, which means paying another round of closing costs. You must consider whether you plan on staying in your home long enough to recoup these costs. For example, if you plan on selling your home in the near future after refinancing, the amount you are saving on your mortgage payments will not likely cover the additional closing costs. Closing costs can be substantial and can easily exceed several thousand dollars. These fees include bank fees, attorney fees, title insurance fees and appraisal fees. Accordingly, it may take several years for the reduction in mortgage payments to offset the substantial costs of refinancing. It is important to consider that lowering your monthly interest payments will cut into your net tax savings. This should be factored into making a fully informed decision.
- Did you consider the length of the loan?
Refinancing also offers the advantage of paying off your mortgage in less time. Rather than starting over with a new 30-year loan, refinancing to a 15-year mortgage could halve the time it would take to fully own your home. This reduction in repayment period also includes the added benefit of a lower interest rate, saving you years of interest. The downside to condensing the length of the loan is that the monthly payments will be substantially higher. Substantial cash flow becomes a major planning consideration.
- Are you switching from a Variable Rate Mortgage to a Fixed Rate Mortgage?
Refinancing your mortgage with a fixed-rate loan also makes sense if you have an adjustable rate mortgage. Adjustable rate loans may save you money in the short-term, but they can be dangerous in the long-term if the rate suddenly increases. In other words, switching from a variable to a fixed-rate mortgage reduces risk in times of rising interest rates.
The decision to refinance involves weighing costs and benefits within your personal financial framework. Consideration must be given towards a variety of issues including current cash position, equity standing, credit score, and job history. If you have any questions or concerns regarding this topic or any other tax matters, please contact your L&B professional at (858) 558-9200.