Record-low mortgage rates have been generating an avalanche of refinance applications, but if you’re age 55 or older, you need to seriously consider refinancing in the context of your retirement planning.
How close you are to retirement has a big impact on this decision: If you have 10 to 15 more years of work ahead of you, your reasons to refinance may be a lot different from someone who intends to retire within a year or two. If you have at least a decade or more to prepare for retirement, your goal could be to shorten your term in order to pay off your loan before you stop working. And if you are retiring sooner and know you can’t eliminate your mortgage balance before your last day on the job, your goal could be to lower your monthly housing payment.
If you have yet to retire, you may be better off not refinancing at all. Just because you can pay a lower interest rate doesn’t mean it always makes sense to refinance – extending your loan term means you must pay interest for a much longer period of time. In fact, if you currently have 10 years or less left on your mortgage, you could end up paying more interest over the life of the loan if you refinance into a 30-year mortgage. Worse, if you choose a 15-year mortgage with higher payments, you could be sabotaging your retirement savings in order to make those mortgage payments.
How to Decide Whether to Refinance
To determine how to structure your refinance or whether to refinance at all, you need to first ask yourself a number of questions:
- Where Will You Live? First, decide where you want to live when you retire. If you want to stay in your home, refinancing to reduce your monthly payments or to more quickly pay off your home in full could make sense. But if you want to move, you need to decide if you’d like to keep your current home as an investment for rental income or sell it so you can downsize. This should be a consideration for any refinance, regardless of where you stand on the retirement timeline.
- Will You Retire With Debt? Ideally, everyone could retire with zero debt and an abundance of savings. Unfortunately, this doesn’t always happen. If you are refinancing into a 30-year mortgage and intend to retire in 15 years, you need a plan for how you will make your mortgage payments in retirement or pay off the loan early. If you can afford a shorter loan term, you can pay off your loan faster and pay less in interest.
- What Loan Payment Can You Afford? While many people are psychologically opposed to retiring with mortgage debt, others are not. Refinancing into a 30-year mortgage with low monthly payments can make sense if you have enough retirement savings to make the payments. Or, you may want to reduce your mortgage payments now in order to invest more each month in your retirement fund. You can continue to take the mortgage interest tax deduction, which will reduce your tax burden post-retirement.
- What Type of Loan Makes Sense? Fixed-rate loans are by far the most popular because it’s easier to plan for the future when you know that your principal and interest payments will stay the same for your entire loan. If you plan to move in a few years, you may be tempted by a super-low adjustable rate mortgage (ARM). However, before you choose an ARM, make sure you know the maximum potential interest rate and payment. Even if you think you will sell your home before your mortgage rate adjusts, circumstances can change. You may want to keep your home and rent it, which could be more profitable if you have a low-interest fixed-rate mortgage. Just don’t assume you can refinance in the future, because no one can accurately predict mortgage rates or home values.
Mortgage Loan Options
Lenders today offer a wide range of loan terms, including the most popular 30- and 15-year fixed-rate home loans, 20-year fixed-rate loans, and even some loans with specific terms geared to your individual needs, such as an 11-year mortgage designed to coincide with your retirement date. Your inclination may be to refinance into a shorter-term loan so you pay if off faster, but payments are higher on a shorter-term loan even if it has a lower interest rate than your current loan. Compare the interest rates and monthly payments on several loan terms, and balance the higher payment against overall interest savings on shorter term loans to find a good match for you.
Remember, even if you choose a 30-year loan, you can always pay off your mortgage faster by making biweekly mortgage payments, paying one extra mortgage payment each year, or simply applying more to the principal every month. This way, if your circumstances change and you lack the extra cash, you can always revert to paying the minimum on your mortgage. Just make sure you don’t refinance into a loan with a prepayment penalty.
Adjustable Rate Mortgages
Some savvy pre-retirees may want to consider the low interest rates on an adjustable rate mortgage (ARM), such as a 5/1 Hybrid ARM. With this mortgage, your interest rate stays the same for the first five years and then can rise or fall according to the limits set by the loan.
If you know you can pay off your home within five years or are positive you will sell it before the fixed interest rate period expires, then this can be a great way to save on your interest payments. That said, you should always be sure you can afford the worst-case scenario with an ARM – the highest possible payment within the caps set by the loan – just in case your plans change.
Cost of Refinancing
While you may be focused on lowering your interest rate, shortening your loan term, or reducing your monthly payments, don’t forget that refinancing isn’t free. If your current lender offers you a low-cost refinance, that can be a great option, but you are still going to need to pay closing costs.
Closing costs vary by state and average about 3% (or $3,000 on a $100,000 loan). If you have enough available home equity, you can usually wrap those costs into your new loan balance, but this means you are paying that $3,000 over 30 years (or 15) and paying interest on it. You can also pay cash for these costs or opt for a “zero cost” refinance, which actually means that while you are not paying out-of-pocket for the refinance, you are paying a slightly higher interest rate to cover those costs for the life of your loan.
A quick calculation can tell you how long it will take to recoup the cost of your refinance. For example, if you paid $3,000 to refinance and are saving $200 per month, it will take you 15 months before you have recouped your refinancing fee.
When comparing mortgage refinance options, be sure to compare the fees and associated interest rates, and consider the impact of those costs on your retirement plan.
Every loan refinancing decision should be made within the context of your personal finances. For example, a couple with plenty of retirement savings and plans to retire within six years could choose a 10-year loan with a low interest rate and make extra payments to eliminate the mortgage before stopping work.
Another pre-retiree with plans to retire in six years could make a huge mistake refinancing into a 10-year loan because she needs to put every available dollar into beefing up her retirement fund. She would be better off keeping her current loan and perhaps making extra principal payments with a biweekly mortgage payment, rather than committing more of her income to her mortgage.
Refinancing to reduce your payments or to shorten your loan term can be a benefit to your retirement plan as long as you make sure you’re balancing your desire to pay off your mortgage with your need for savings. Compare not only your interest rate, but also your monthly payments and the overall interest you will pay for various loan terms to determine which one matches your needs best. For many homeowners, the cost of refinancing will not justify a new mortgage at all.
Have you ever refinanced your mortgage? If so, have you found it to be beneficial?