With interest rates at historically low levels across the U.S. and much of the globe, now might be a great time for homeowners to refinance their mortgage and benefit from lower rates! While the penalty fees to break your mortgage early can seem astronomical at first, the interest savings over the remaining term of the mortgage can still make it worthwhile.
A thorough mortgage refinancing analysis (as this article provides with the free template below!) can help give borrowers piece of mind that they are making the right decision by refinancing. Doing your homework on whether refinancing your mortgage makes sense just might be the easiest money you ever made!
Small Interest Rate Differences Add Up!
Interest rate differences of 0.5% might not seem like a lot, but quickly add up when we are talking about $500,000 mortgage balances. In that situation with a $500,000 mortgage balance, a 0.5% rate difference would imply savings of $2,500 per year! Over the remaining term of the mortgage, of say 3 years, these annual savings could add up to $7,500.
Some of these interest savings will be offset by the penalty fees involved with breaking your mortgage early, which we will discuss next. However, for many people the net savings over the remaining term of your mortgage can still be significant and justify the change.
Side Note: Remember that this 3 year remaining term of your mortgage is different than the remaining years to maturity of the mortgage, in say 20 years. By refinancing early, homeowners are locking themselves into a new mortgage term, of say 5 years.
Mortgage Break Fees are Variable
Mortgage break fees are variable with time, interest rates, mortgage principal outstanding, and the type of mortgage you have, to name some of the major pieces. The good news is that because break fees are variable, they normally adjust to make refinancing your mortgage worthwhile once certain milestones have been reached.
Another piece of good new in terms of mortgage break fees is that they can be capitalized or added to your new mortgage. This means that there is nothing being paid out of pocket by homeowners for refinancing! If homeowners have done their homework and are making a smart decision by refinancing, monthly mortgage payments will still be lower and the maturity of the mortgage can remain the same, even with the newly capitalized mortgage break fee added.
Break fees are normally in the fine print of the mortgage documentation and are difficult for individual homeowners to calculate, but a call to your mortgage provider will quickly get you the number. Websites have even begun to spring up that have compiled each major provider’s mortgage break fees rules and allow individuals to easily get an estimate of what their personalized break fee would be.
Mortgage Refinancing Analysis
The attached spreadsheet gives readers the tools they need to make a smart decision on whether to refinance their mortgage or not. After getting their actual break fee from their mortgage provider and shopping around to negotiate the lowest new mortgage rate they can get, homeowners can plug into the spreadsheet the specifics of their current mortgage as outlined below and highlighted in orange on the spreadsheet for ease of reference.
- Input the principal amount outstanding on the mortgage
- Input the remaining term (remember that term is different than maturity)
- Input your current mortgage rate
- Input the early refinancing break fee
- Input the new mortgage rate being marketed
The output of the analysis shows the net savings homeowners can expect on both an annual basis and also over the remaining term of your current mortgage. The penalty fee in the analysis has been capitalized to the loan with the additional interest to be charged on it taken into account. It should also be noted that this is a simple cost benefit analysis which ignores the effects of principal repayments over the remaining term. Taking into account principal repayments would slightly reduce the net interest savings depending on the number of years until maturity of the mortgage and the portion of monthly payments going to principal repayment compared to interest.
Important to note from this analysis is that the penalty fee is being amortized in the analysis over the remaining 3 years of the mortgage, but the new refinanced mortgage term may continue longer than this, say 2 years longer if a new 5-year term is selected. This means that homeowners might benefit even further than this analysis suggests if interest rates increase before the original mortgage term of 3 years would have ended, which is when the homeowner would have naturally been able to get a new rate.
Fixed or Variable Rate Mortgage?
Variable rate mortgages normally carry cheaper interest rates than fixed rate mortgages, but homeowners are exposed to changes in interest rates during the term of the mortgage. If interest rates drop further or stay flat, they will benefit from the lower variable interest rate mortgage. But if interest rates rise quickly, homeowners might end up paying higher interest rates than the fixed rate they could have locked in to begin with.
However, variable interest rate mortgages from many providers allow borrowers to lock in their variable interest rate mortgage to a fixed-rate when they choose without charging a break fee. This ability to swap your variable rate for a fixed rate means that if homeowner’s budgets can stomach one or two interest rate increases before they decide to lock into a fixed rate, they might benefit from the risks of choosing a lower variable rate mortgage in the short-term.
Takeaway
The current low interest rate environment presents the opportunity for homeowners to refinance their mortgage to a lower rate. While the penalty fees for refinancing your mortgage early might seem foreboding, they can be more than offset by the interest savings over the remaining term.
Remember that break fees can also be capitalized to the new mortgage so that there is nothing being paid out of pocket. Doing your homework on whether refinancing your mortgage makes sense just might be the easiest money you ever made!
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