Here is the next installment in our the Reader’s Questions Series which highlight questions emailed to me by you, the readers of Money Q&A. Be sure to find out at the end of this article how you can receive a free copy of Dave Ramsey’s book, The Total Money Makeover if your money question is chosen to be featured in an upcoming week’s blog post.
If you’re not familiar with Dave Ramsey’s book, you should run right out and get it. It is one of my top ten best personal finance books that everyone should read. Now….on to our reader’s question.
Tread carefully when looking to refinance your home. I recently received a question from a reader, Benjamin, about refinancing his home.
My bank is offering a “home equity refinance” which would lower my rate from 4.625% to 3.89% and drop the remaining years from 26 to 15. It also eliminates my Private Mortgage Insurance (PMI). Is this is a normal usage for home equity loans, or should I be leery of this loan offer?
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Tread Carefully With A New Home Refinance
Background: Benjamin also offered this information as a little more background. “I am currently 4 years into a 30-year mortgage and have paid off almost 10% of the principal. My bank is offering a “home equity refinance” which would lower my rate from 4.625% to 3.89%, and drop the remaining years from 26 to 15.
Of course, there is a higher payment, but it also eliminates my PMI of ~$180 per month, and since I’m paying extra to get the principal down faster, it come out to about the same as my current payments.
The bank manager says that even though I only have 10% equity, once the new loan pays off the first loan, I will have 100% equity (for a split second before the new loan takes it all away again). It all sounds a little too good to be true to me because I don’t have the equity on which to base the loan in the first place. I’ve been searching for a few months about how to eliminate my PMI payment sooner, and had just given up when the bank manager offered this to me out of the blue.”
While I don’t have all the facts in front of me, there are a few things to your question that are a little troubling.
It’s Hard To Avoid PMI With Low Equity
I would be very surprised if you could avoid PMI with only 10% equity. You typically need 20% and then most states require your bank to do away with PMI when you reach 22% equity.
The whole point of PMI is to protect banks from borrowers who do not have enough equity. They want people to have “skin in the game” so to speak. PMI hedges the banks’ bets.
Also, I’d be concerned about the closing costs for refinancing. They can typically be upwards of 3% or more of your new loan balance for your home mortgage which can negate a lot of your savings especially if you may move in the next few years.
The Alternative Is To Continue To Pay Extra Principle
You may be better off continuing to pay more principle every month like you have been instead of refinancing. That may be a better idea to continue doing that. A rule of thumb is that it makes sense to refinance if the interest rate drops a full percentage point in most cases and if you’ll continue to live in the house for years to come due to the upfront fees that get wrapped into your new loan.
You can find out if a refinance will save you money in the long run by using a refinance calculator like the one from Zillow or BankRate.com. Both can be great tools to help you make informed decisions about refinancing.
It also does not hurt to shop around for a better mortgage. You do not have to accept the offer that your current mortgage lender makes you. Shop around for multiple mortgage offers on sites like Lending Tree. Mortgage rates are still low. Refinance & Lower Your Payment!
At the very least, I would go back to the banker and get clarification about the home refinance offer and have them spell it all out for you in writing so you understand everything before signing on the dotted line.
If an offer for a home refinance from your banker or mortgage broker to eliminate PMI is too good to be true, then you should tread very carefully.
Past Readers’ Questions:
- Is It Better To Save For Closing Costs Or Pay Down Loan?
- Is A $1,000 Emergency Fund Enough To Start?
- How To Prioritize Which Bills To Pay First
- Should You Put Your Emergency Fund In Mutual Funds?
- How Do You Start Saving If You Live Paycheck To Paycheck?
- How To Find A Payment Plan Without Cutting Necessities
- Is My Money Save In A Bank?
- What To Invest In After The Company Match
Do you have a money question that you would like to ask? Email me your money, investing, retirement, savings, or other question to Questions[at]MoneyQandA.com. If I pick your question for the next article in the series, I’ll send you a free copy of Dave Ramsey’s book, The Total Money Makeover, or you can pick from any of these other free books instead.
Thank you all so much for all of the questions! Please keep them coming!