August 2021, Approved By Charles

I’m asked frequently when does it make sense to refinance. The answer is almost never cut and dried. There are many reasons why a refinance might make sense and just as many as it may not make sense. It really does depend on the individual person and their specific situation. But, for the sake of this article let’s talk about my approach when talking with someone.

The Long View:

If they are looking only to lower their interest rate I usually recommend a savings of 1/2% in the rate that usually makes the most sense, but even in this case, it might not make sense. It also depends on the loan amount. Here are a couple of examples:

Both examples assume the following. They are two years into a 30 year fixed mortgage, their rate is going from 3.50% to 3.00%, they have 25% equity, or 75% loan to value. We are only going to consider savings on principal and interest payments. For the sake of this demonstration, their credit score and debt to income (DTI) are not a consideration.

The first example is a property worth $400,000 and the new loan amount for a 30 year fixed mortgage would be $300,000.

Although only saving $82.32 per month over 30 years they will save $29,635.91 in payments and $29,361 in interest. Not insubstantial numbers. If they invested that $82.32 savings per month over the next 30 years in an S&P 500 fund, averaging 10% annual return, over thirty years you would have invested a total of $29,635.20 and earned $157,998.86 in interest for a final balance in 30 years of $187,634.06. Even if they don’t invest the monthly savings of $83.32 per month they will save $29,535.91 in out-of-pocket monies.

The second example is a property worth $150,000 and the new loan amount for a 30 year fixed mortgage would be $112,500.

Although only saving $30.87 per month over 30 years they will save $11,113.46 in payments and $11,010 in interest. Also, not insubstantial numbers. If they invested that $30.87 savings per month over the next 30 years in an S&P 500 fund, averaging 10% annual return, over thirty years you would have invested a total of $11,113.20 and earned $59,249.57 in interest for a final balance in 30 years of $70.362.77. Even if they don’t invest the monthly savings of $30.87 per month they will save $11,113.20 in out-of-pocket monies.

A note about the numbers. There is a slight rounding error in my two systems which accounts for a difference of under a dollar out of pocket in both scenarios over 30 years.

In summary, the math tells the story of these refinances. In almost any scenario, if you look at the long view, you end up coming out far ahead by a refinance. Obviously the greater the difference between your current rate and the new rate the more you stand to save or save and earn, over 30 years if you choose to invest. It also goes without saying that just because the S&P 500 index has an average return of 10% over the last four decades, there’s no expectation that will continue, or won’t, for that matter. Investing comes with risk. Savings, don’t.

If you’d like me to run specific numbers for you don’t hesitate to reach out at approvedbycharles@gmail.com or if you are ready to get your refinance started go to https://www.approvedbycharles.com/apply

Whenever you put less than twenty percent down on a home purchase, or anytime you use an FHA mortgage regardless of down payment, you must pay for Mortgage Insurance. There are multiple types of mortgage insurance and their costs vary dramatically.

Let me start by making the following statement. Mortgage insurance is in place to protect the lender’s investment. If you were to default on the mortgage the lender can sell the home and if it takes a loss they can make a claim against the mortgage Insurance for any loss.

Using the example of an FHA (Federal Housing Administration) mortgage first there are always two components to mortgage insurance. There is a 1.75% upfront mortgage insurance premium. This is calculated as the purchase price minus the down payment multiplied by 1.75%. This is paid upfront at closing, hence the name, and is usually rolled into the mortgage. Thus on a $400,000 home purchase where the borrower is putting the minimum of 3.5% down their upfront mortgage insurance premium would be $400,000 minus 3.5% gives an amount due of $386,000. Taking this number and multiplying by 1.75% gives an upfront mortgage premium amount of $6,755 and adding this to the amount due after the down payment would bring the actual loan amount to $392,755.

The second component is the monthly premium. With an FHA mortgage that monthly premium is .85% of the loan amount if the borrower puts down less than 5% and .80% of the loan amount if the borrower puts down 5% or more. If you put down more than 10% on an FHA loan the monthly mortgage insurance premium drops off after 11 years, otherwise, it is the life of the loan. (Note all numbers are based on a 30 year fixed mortgage. If you have a term other than 30 years these numbers vary)

To calculate the monthly mortgage insurance premium you take the loan amount, using our example of $392,755 and multiply it by .85% if the down payment is less than 5% and .80% if the down payment is 5% or more, and then dividing that number by 12 to get a monthly premium amount. Again using our example of 3.5% down and a $392,755 loan amount the monthly mortgage insurance premium would be $392,755 times .85% or $3,338.42 per year or $278.20 per month.

Remember this important piece, unless you put down more than 10% on an FHA mortgage the monthly mortgage insurance premium is for the life of the loan. This means it stays required until you sell or refinance. Once you get to 20% equity or more in the home you should seriously consider refinancing to a conventional loan to remove that monthly mortgage insurance premium.

With conventional mortgages mortgage insurance is actually classified as PMI or private mortgage Insurance. And you guessed it, this Insurance is not standardized by the feds, and their costs, and flexibility can vary widely. One of the main ways that PMI differs from MI like put in place on an FHA loan is that there is no upfront mortgage insurance premium it is just a monthly payment. It also drops off once you reach 78% equity by payments of principal or if your value has increased to the point you have that much equity. There are processes in place to allow you to call the servicer and have the PMI removed.

Additionally, PMI is usually lower cost per month, depending on numerous credit and qualification factors. It also has the flexibility to pay a partial upfront payment at closing to lower your monthly MI payment or you can pay a single premium for the entire policy at closing which may make sense for you.

In the end, while mortgage insurance only protects the lender the fact that it exists allows you to put less than 20% down and purchase a new home. It is a means to an end and serves an important purpose in helping people own real estate.

As usual, if you’d like to talk with an honest and transparent lender or to start your mortgage application go here: www.approvedbycharles.com/apply

Should I Refinance: Rate Reduction with Investment

The What and Why of Mortgage Insurance