Should We Refinance Our House?

We’ve been in our house about 2 years.  We bought just at the end of 2005 and locked in a decent 5.75% interest rate on a $250,000 fixed 30-year loan.  Just after we locked in, rates started to climb, ultimately rising into the high sixes about 12 months later.  We timed the market pretty well with respect to rates.  In fact, when we closed on the house about 45 days after lock-in, the closing agent remarked that it had been several weeks since she had closed a loan in the fives.  (…made us feel pretty good at the time). 

Even still, we knew our 5.75% rate wasn’t incredible.  Two of our friends living in a nearby townhome held a 4.5% fixed 15-year note.  That was a full 1.25% below ours.  They timed the market perfectly, refinancing at just the right time in 2002-2003.  On $250,000, a 1.25% reduction would amount to a savings of $3250/year, or about $270/month.  Granted, we would lose the tax deduction for that interest, but we could save that money in a Roth IRA and reap tax benefits at retirement, making the overall savings pretty much a wash.  Even though the payments on a 15-year note would be a little harder to manage, the idea is consistent with our family’s goal to be completely debt free in our mid-30s.

About two months ago, I noticed mortgage commercials had started to resurface en masse on local radio stations.  “Refinance today!” they urge; announcers noting that interest rates are once again at “their lowest in years.”  Of course, most commercials end with the obligatory act now warning… “Time is limited!  These rates won’t last forever!” 

After two months of the barrage, I figured maybe there was something to all this marketing.  So I called several agents, and used an online mortgage broker to see what kind of rates are out there for folks with good credit looking to move into a shorter-term loan.  (My experience with the broker is the subject of a later, shorter post).  Since we’re willing to move into a 15-year note, I figured we’d have a shot at getting a rate that might sway us.

I received a number of offers, but I’ll only focus on two here, since these represented two different sides of the spectrum.  One offerred low up front cost with a higher rate, the other higher up front costs with a lower rate.

(Note that for all lenders, there is approximately $800-$1000 in fees that are incurred regardless of the lender you choose.  Those fees cover things like title search, title insurance, a closing agent’s time, an appraisal, etc.  On top of these fees, lenders add their own fees.  I used $1000 as the base closing cost across all loans.  The lenders fee are called out below).

Scenario 1: Wells Fargo Home Mortgage

Wells Fargo offered a 15-year fixed 5.5% rate with .125% discount points ($312.50).  Wells Fargo charges a standard $399 fee to close loans.  This makes the total cost to settle $1000 + $400 + $312.5 = $1712.50.  At a 5.5%, we would save .25% per year, or $625 / year.  This makes the payback period for us 2.74 years.

(as an aside: Wells Fargo is our current lender and we have been very happy with them).

Scenario 2: Home Advantage Mortgage

Home Advantage Mortgage offerred a 5.125% rate with .097% discount points ($242.50).  However, Home Advantage required a whopping $4499.00 to close the loan.  They did provide a $350 credit towards an appraisal.  This made the total cost to settle $1000 + $4499 + $242.50 - $350.00 = $5391.50.  At a 5.125%, we would save .625% per year, or $1562.5/year.  This makes the payback period 3.45 years.

Which Loan Did We Choose?

In order to close the loan, I generally look for an 18 month or less payback period, so it doesn’t look like it’s in the cards for us right now. 

If we were going to select one of these options, it would be very hard to do.  While Wells Fargo offers a shorter payback period, Home Advantage’s offer would provide far greater savings beyond year 5.  Since we’ll likely stay in this house for 10+ years, the HAM deal makes more sense.  That said, I’m willing to take the gamble that either rates will come down further in the next 4 years or we’ll move to a different home. 

What do you think?  How often do you think about refinancing?  Have you refinanced lately?  If so, what method did you use to determine that it was a good deal?

Photo courtesy of SqueakyMarmot.