Housing is one of the biggest expenses most people shoulder, so reducing your monthly housing bill can make a big difference in your overall budget. For the millions of people who have a mortgage, refinancing provides one of the best options for saving money. And with interest rates hovering near record lows, the savings can be substantial.
Refinancing with a lower-rate mortgage will reduce monthly payments. For example, the monthly payment on a typical $200,000, 30-year loan at 6.6 percent is $1,277. (We’ll ignore taxes and insurance payments, as these vary widely depending on the location of the house and other factors.) Reducing the loan’s interest rate to 4.5 percent cuts the monthly payment to $1,013, for a monthly savings of $264.
Even more substantial savings can be captured over the long run by refinancing at a lower rate. The National Bureau of Economic Research provides an example: On a typical $200,000 loan with a 30-year term at 6.6 percent, reducing the interest rate to 4.5 percent saves the borrower more than $80,000 over the life of the loan (refinancing costs factored in). More impressive yet, a reduction of the rate to 3.35 percent results in eye-popping savings of $130,000 over the 30-year period.
Where to Look for Savings
Homeowners can save on mortgage costs in different ways. There are several basic elements to play with: the size of a loan, the term of the loan, the rate of the loan. Additionally, the fees involved in refinancing are variable and can be reduced. Here are some factors to consider:
Shop around for the best deal.
There is quite a bit of variation in rates and fees from different lenders, so it pays to look at many potential providers. Call multiple brokers and banks for quotes; the more options you gather, the better your chance of landing a good deal. Use online calculators to test the numbers. And don’t look at only the big lenders. HSH.com, a good source of information on mortgages, encourages borrowers to consider credit unions in particular. While not all credit unions offer refinancing, those that do usually provide excellent customer service and a friendly environment.
Consider different loan terms.
Most borrowers are aware that lower rates mean savings in both the long and short term. But another important variable is the length of the loan. Do the math on a 20-year or even a 15-year loan versus the more typical 30-year package. Although the monthly payment will likely rise a bit, the long-term savings are usually substantial, and shorter-term loans usually have lower rates. For example, a 30-year loan for $200,000 at 5 percent costs $1,381 a month. Over the term of the loan, total interest amounts to $186,512. The same $200,000 obtained through a 15-year loan at 3 percent costs about $300 more a month, but the total interest paid is only $48,609 -- a savings of $137,903.
Have your paperwork in order.
One of the biggest hurdles in the refinancing process is the sometimes onerous requirements for proof of income, taxes, insurance, and other financial details. To make sure the best offer doesn’t slip away, get all of your paperwork ready. This list of documents to gather, supplied by Chase, is a good starting point.
Fix your credit score.
A weak credit score makes refinancing much more difficult. Borrowers should make sure they know their credit scores. By law, everyone is entitled to a free annual credit report from the big credit-reporting agencies: Experian, Trans-Union, and Equifax. Get your reports and review them for fixable problems or mistakes. Even the most vigilant consumer can end up with an unpaid medical bill or a false report of an unpaid debt. Fixing those problems can help move your credit score toward the magic 720 level, when home credit becomes much easier to get.
For homeowners who are having trouble making their current mortgage payments, the federal government may be able to help. The Making Home Affordable Program run by the Departments of the Treasury and Housing and Urban Development offers loan modifications to eligible borrowers. While the program has been criticized for a lack of effectiveness and weak participation levels, it does provide options for potentially millions of borrowers. The website includes a tool that enables homeowners to explore what’s available. You can also check with mortgage giants Fannie Mae and Freddie Mac directly to discuss eligibility. Contact Fannie at 1-800-7-FANNIE and Freddie at 1-800-FREDDIE during business hours.
If refinancing fails, consider other options.
Some borrowers will be unable to refinance regardless how well they shop around and prepare. Lenders may be unwilling to overlook weak credit scores, job loss, or soft property values. But all is not lost. Even without refinancing, there is a way to save on the total long-run cost of the mortgage: Pay extra money each month (if you can afford it) to shrink the amount of interest paid over the life of the loan. Financial gurus note that “prepaying” might save a homeowner as much as refinancing would. This calculator lets you create different prepayment scenarios. You can enter a target interest rate, and the calculator will compute the extra payments required each month to match that rate. Prepayment may cost more on a monthly basis, but the long-term savings can make it worthwhile.
Despite the potential savings, many homeowners have not opted to refinance even as mortgage rates hover in historically low ranges. The economist Mark Thoma recently wrote that potential savings worth billions of dollars are waiting to be grabbed by homeowners if they would only refinance. Experts aren’t sure why so few have done so, but stagnant wages, lack of knowledge about a complex system, and widespread mistrust of financial institutions following the collapse of the housing bubble are likely candidates. Whatever the cause, millions of owners stand to benefit and should be encouraged to investigate their options.