With mortgage rates back down to rock-bottom levels, homeowners are scrambling to refinance and cut their monthly payments, often by hundreds of dollars.
If you're thinking of joining the rush to refi, personal finance author and TV personality Suze Orman wants you to pause and take a deep breath — so you won't bungle it.
"It makes me so crazy how most homeowners make a huge mistake when they refinance," she says.
It's a blunder Orman says can easily saddle you with much higher interest costs, even if you manage to land a mortgage rate your friends will envy.
'So very wrong'
The average 30-year fixed mortgage rate has dipped below 3% once again, and homeowners who dragged their feet last time are refusing to miss out. Earlier this month, refinance activity climbed to the highest level since February.
Yet Orman says many enthusiastic refinancers are making a costly mistake: automatically reaching for another 30-year mortgage, even if they've been paying down their existing 30-year loan for years.
"This is so very wrong," the personal finance guru writes in her blog.
Suppose you've been paying down your original loan for 14 years, then you take out a new 30-year mortgage. "Sure, the new mortgage is at a lower interest rate, but you just extended your mortgage payment on this home to 44 years!" she says.
When a 30-year refinance might make sense
The 30-year fixed-rate mortgage is America's most popular home loan, so it might naturally be the go-to for homeowners who want to trade in their existing mortgages for a better deal.
And it's the obvious choice if your mortgage is fairly new. Early last year, 30-year mortgages were averaging around 3.75%
With rates at their current levels, the mortgage data firm Black Knight estimates 15.1 million homeowners could save an average $298 a month by refinancing.
But, like many experts, Orman generally recommends refinancing to a new loan with a shorter term.
"My rule of refinancing is that you are to never extend your total payback period past 30 years," she says in the blog.
Let's say you are indeed still holding on to a 30-year loan you took 14 years ago during the summer of 2007.
Back then, rates were averaging a stiff 6.4%. (Seriously, you should have refinanced before now.) Say your mortgage was originally in the amount of $250,000; you'd now have a balance left of about $188,000.
Why to consider refinancing into a shorter-term loan
Today, rates on 30-year fixed home loans are averaging just 2.99%, according to the Mortgage Bankers Association.
If you were to refinance that $188,000 balance to a new 30-year mortgage at 2.99%, and stay with the loan for the entire term, the lifetime interest would be over $97,000.
You could choose to do a 15-year refinance instead. Fifteen-year mortgages have lower interest rates than 30-year loans: The average for a 15-year is currently just 2.35%.
With a $188,000 15-year mortgage at 2.35%, you'd pay interest of just roughly $35,200 over the life of the loan. That's $61,800 less than the 30-year refinance.
But many refinancers don't opt for a 15-year loan because they don't think they can afford the higher payments:
The monthly payment (principal plus interest) on a 30-year refi in the amount of $188,000 at 2.99% is about $790.
The monthly payment (principal plus interest) on a 15-year refi in the amount of $188,000 at 2.35% is $1,240.
But Orman says in recent years 15-year mortgage rates have been so low "that you may be able to refinance your remaining balance and end up with a payment that is not much different than what you were paying on your 30-year."
And in our example, it's true:
The monthly payment (principal plus interest) on the original 30-year mortgage in the amount of $250,000 at 6.4% was $1,563. The new 15-year loan costs about $320 less per month.
How to choose
Whichever type of mortgage you settle on for your refinance, you want to feel certain you're going to stay in the home a few years.
"There is no such thing as a free refinance," Orman says. "You will either pay closing costs — which can be a few percentage points of your loan cost — or a higher interest rate."
Refi closing costs average about $3,400, according to the most recent data from ClosingCorp. You won't want to move until after the savings from that new, lower mortgage rate of yours have paid off the closing costs — and then some.
If you believe you're in the house for the long haul, refinancing into a 15-year mortgage can be the wise choice, if you can handle the payments. Your interest rate will be lower and you'll pay tens of thousands of dollars less in interest over time.
Going with another 30-year mortgage and its lower monthly costs can be the smarter move if you're not likely to stay in the house long term. If you may be leaving within a few years, what does it matter if you have a 30- or a 15-year loan?
Before you settle on any loan, always shop around. Get mortgage offers from several lenders to find the best rate available in your area and for a person with your credit score. Don't assume that the very first lender you hit up will offer you the lowest rate possible.
Be sure to put your comparison shopping skills to use when you get your renewal notice from your home insurance company, too. You can easily get multiple home insurance quotes and compare rates, to find what works best for you.
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.