Refinance Your Mortgage Today – Saving More Than You Think

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“We’re not even thinking about thinking about raising rates”
– Fed Chairman Jerome Powell
June 11, 2020

With mortgage rates where they are today and with the Fed funds rate essentially at zero now is the best time as any to refinance your mortgage.

If you take a look at your monthly budget your mortgage is more than likely to be your largest monthly fixed cost. Generally, your housing costs should not exceed more than 25-30% of your take-home pay. Yet the average married couple with kids spend 32% on housing and single people spend almost a whopping 36% according to data from the Bureau of Labor Statistics.

Refinancing is a smart choice as you try to lower your monthly fixed costs. A refinance can possibly save you thousands of dollars each year.

In this low-interest rate environment, everyone and their mother-in-law with half a decent credit history should be refinancing. I just went through the refinancing process myself, which I should have probably undertaken 6 months ago. But hey! better late than never.

Rates are at multi-year lows, the average 30-year fixed mortgage rate started 2019 at 4.68% and steadily declined before closing out the year at 3.93%. In 2020, rates remained stable until the pandemic hit and because of the Fed moves have since trended lower closing last week at 3.38%.

My mortgage was financed at a rate of 3.625% when I purchased my house back in the middle of 2018. I have been watching the rates closely since then and jumped on the chance to refinance when the opportunity presented itself. I just closed my refinancing last month at a rate of 2.875% on a 7/1 ARM.

Yes, I can see that question coming from a mile away. Why a 7/1 ARM especially when rates are so low why didn’t I lock in a low 30-year fixed rate? Well, the simple answer to that is because I don’t intend to stay in my current house for more than 7 years and the mortgage is not transferable when you sell only the house is. 7/1 ARM interest rates typically tend to be meaningfully lower than 30-year rates and in this benign interest rate environment, I see little risk in getting a shorter fixed duration mortgage.

Lets take the example of Peter who is looking to refinance his $500K mortgage. He does the required research and legwork to get the best interest rates for his mortgage and comes up with the following.

DurationInterest RateMonthly Payment
30 Year Fixed3.375%$2,210.48
10/1 ARM3.0%$2,108.02
7/1 ARM2.75%$2,041.21

Peter looks at the monthly payments and figures out that if he goes with the 7/1 ARM he would be saving $169.27 per month vs. the 30 year fixed option and $66.81 per monthly vs. the 10/1 ARM. That’s a very simplistic way of comparing Mortgage rates and payments and most of us would probably fall into the same bucket as Peter on how we compare mortgage payments and rates.

Peter thinks that if he chooses to go with the 7/1 ARM option he would save $14,218.68 over a 7-year time horizon vs the 30-year fixed and $8606.64 vs the 10/1 ARM as summarized in the table below.

Loan ComparisonSavings over a 7-year horizon
7/1 ARM vs. 30 year Fixed$14,218.68
7/1 ARM vs. 10/1 ARM$8,606.64
10/1 ARM vs. 30 year Fixed$5,612.04

However, here its a case of more savings than meets the eye. For that, we have to dig a bit deeper and look at the amortization schedules of each loan option. You will realize that the savings are much higher than just comparing monthly mortgage payments as shown above.

Here is the Annual amortization schedule for a $500k mortgage for the various loan options that we considered above.

30-year fixed loan at 3.375%

YearBeginning BalanceAnnual InterestAnnual PrincipalEnding Balance
1$500,000.00$16,724.31$9,801.45$490,198.53
2$490,198.53$16,388.34$10,137.42$480,061.10
3$480,061.10$16,040.86$10,484.90$469,576.19
4$469,576.19$15,681.45$10,844.31$458,731.89
5$458,731.89$15,309.76$11,216.00$447,515.87
6$447,515.87$14,925.30$11,600.46$435,915.41
7$435,915.41$14,527.67$11,998.09$423,917.32

For a 30-year fixed loan total interest paid over a 7-year time horizon is $109,597.69 and the total principal paid is $76,082.63.

10/1 ARM at 3.0%

YearBeginning BalanceAnnual InterestAnnual PrincipalEnding Balance
1$500,000.00$14,857.24$10,439.00$489,561.00
2$489,561.00$14,539.73$10,756.51$478,804.48
3$478,804.48$14,212.56$11,083.68$467,720.80
4$467,720.80$13,875.43$11,420.81$456,300.00
5$456,300.00$13,528.07$11,768.17$444,531.82
6$444,531.82$13,170.15$12,126.09$432,405.70
7$432,405.70$12,801.29$12,494.95$419,910.75

For a 10/1 ARM loan total interest paid over a 7-year time horizon is $96,984.47 and the total principal paid is $80,089.21.

7/1 ARM at 2.75%

YearBeginning BalanceAnnual InterestAnnual PrincipalEnding Balance
1$500,000.00$13,613.53$10,880.99$489,119.06
2$489,119.06$13,310.50$11,184.02$477,935.10
3$477,935.10$12,999.07$11,495.45$466,439.67
4$466,439.67$12,678.90$11,815.62$454,624.11
5$454,624.11$12,349.85$12,144.67$442,479.49
6$442,479.49$12,011.62$12,482.90$429,996.65
7$429,996.65$11,664.00$12,830.52$417,166.17

For a 30-year fixed loan total interest paid over a 7-year time horizon is $88,627.47 and the total principal paid is $82,834.17.

Total Payments Made over 7 years for each loan

Loan OptionTotal Interest Paid in 7 yearsTotal Principal Paid in 7 years
30 year Fixed$109,597.69$76,082.63
10/1 ARM$96,984.47$80,089.21
7/1 ARM$88,627.47$82,834.17

With a 7/1 ARM not only do you make the lowest interest payments but you also build up equity in your house faster with higher principal payments.

True Savings of a 7/1 ARM loan vs a 30-year fixed over a 7-year time horizon would be $27,721.76 or $330 a month vs. what Peter thought to be $14,218.68 or $169.27 per month.

Similarly, true savings of a 7/1 ARM loan vs a 10/1 ARM over a 7-year time horizon would be $11,101.96 ($132.16/month) vs. what Peter thought to be $5,612.04 ($66.81/month).

The interest payment component of the loan and the principal equity building portion often tends to be overlooked as folks like Peter generally tend to focus on the monthly payment amount because that’s the number that is visible. If you peel the onion you will realize that not only do you end up saving on the monthly payment but also a significant amount in interest payments and build equity faster.

So coming back to the question I was asked repeatedly – Why a 7/1 ARM especially when rates are so low why didn’t I lock in a low 30-year fixed rate? My answer is why pay more when you are only going to be utilizing the loan for 7 years and enjoy significant savings over that time period.

Some may argue that 7 years is too short a time horizon. To those, I would offer the 10/1 ARM option because you still end up saving $22,894.50 ($190.78/month) vs a 30-year fixed rate over a 10-year time horizon.

Lets focus on a few things that you need to have in place before you go in for a refinance in order to get the best possible rates. The documentation requirements can be onerous and do require patience in dealing with the mortgage service provider. With the current backlog for refinancing at elevated levels, expect the process to take anywhere between 60-90 days for a refinance to be completed.

Some of the must haves in order to get the best possible rate include:

  1. Excellent Credit Score or a score above 750
  2. Steady employment history preferable more than 2 years in the current job.
  3. None or very minimal outstanding credit card balances.
  4. Taxes filed on time.

If you already have all of the above in place, I would shop around and lock the lowest rate one can find in the marketplace.

Consider your credit score first 

Whether you want to refinance your mortgage, auto loan or student loan, there’s one thing you absolutely need to have, and that’s good credit. If your score is below 620, then you’re going to have a harder time qualifying to refinance. For instance, mortgage rates run on a sliding scale, which means applicants that have a good score of 720 or higher will receive better rates. Best rates are generally reserved for scores of 760+. So make sure to check your credit score to see if it’s in good shape before inquiring any further about refinancing.

If your credit score is not in good shape make sure you understand why and take the necessary steps to improve your score. One of the reasons why I delayed my refinance was due to less than optimal credit score. It took me around 4 months to improve my credit score by 45 points by paying close attention to what goes into a credit score.

You can check your credit score for free at

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Assess your current terms, beginning with your mortgage 

You may choose to refinance your mortgage in order to lower your monthly payments. This can be done by either extending your loan term (how many years you’ll be making payments) or lowering the overall interest rate. 

Don’t forget, refinancing is essentially replacing your current mortgage or loan with a new one with a more favorable rate or timeframe, which means your loan term starts over. But if you have good credit and your financial situation can benefit from it, then refinancing might be worth its weight in gold, no matter the length of the loan term. Ultimately, it’s up to you to decide what’s best for you. 

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