'So very wrong'
Mortgage rates have plunged to record lows in 2020 as the coronavirus crisis has rattled investors and caused the Fed to slash interest rates nearly to zero to prop up the economy.
Low rates prompted nearly 1.7 million homeowners to refinance during this year's April-through-June quarter alone — more than double the number who took out fresh loans during the same period in 2019, according to Attom Data Solutions.
Orman says the costly mistake most of those recent refinancers probably made was to automatically reach for another 30-year mortgage, even if they'd been paying down their existing 30-year loan for several years.
"This is so very wrong," she writes, in her blog.
The personal finance guru says suppose you'd been paying down your original loan for 14 years, then took 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 current mortgage is fairly new. Millions of people who financed their homes at the beginning of 2020 — when 30-year mortgages were averaging around 3.75% — could save an average an average $289 by refinancing at today's low rates, the mortgage data firm Black Knight has estimated.
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 onto a 30-year loan you took 14 years ago during the summer of 2006 (when Shakira could be heard everywhere singing that "Hips Don't Lie").
Back then, rates were averaging a stiff 6.5%. (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.
Rates on 30-year fixed home loans are currently averaging 2.99%, according to mortgage company Freddie Mac. 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 total about $97,000.
Why to consider refinancing into a shorter-term loan
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 2.54%.
With a $188,000 15-year mortgage at 2.54%, you'd pay interest of just roughly $38,000 over the life of the loan. That's $59,000 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 $791.
- The monthly payment (principal plus interest) on a 15-year refi in the amount of $188,000 at 2.54% is $1,257.
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 6.5% was $1,580. The new 15-year loan costs $323 less per month.
How to make your decision
Whichever type of mortgage you choose for your refinance, be 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."
Average mortgage closing costs now top $5,700, according to 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, which means getting mortgage offers from several lenders to find the best rate available in your area. Don't assume that the very first lender you hit up will offer you the lowest rate possible.
Comparison shop 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.