Mortgage rates are at or near all-time lows. If you have good credit, you may be able to refinance your mortgage with a 30-year fixed rate in the neighborhood of 3%.  A 15-year fixed or 20-year fixed would likely have a slightly lower interest rate.

The first question you have to ask is whether it makes sense to refinance at all.  If you are already at 3.5% or lower, it probably doesn’t make sense.  Sometimes your current mortgage holder will offer a streamlined refinance with little or no closing costs.  This would be the only situation where it might make sense to refinance into a rate that is only half a percentage point less.

You might ask why a lender would allow you to refinance with minimal closing costs.  The answer is that the lender doesn’t want you to refinance with another lender and lose you as a customer.  I am not sure how common it is for lenders to have these types of offers today, but I did this with a condo I had many years ago. I paid zero closing costs and got a better rate.

Many people wonder if it is smart to refinance because they wonder if rates will go lower.  I don’t think this is a good strategy. Nobody knows where rates are headed in the next month or the next year.

If you are borderline on whether to refinance, then maybe it makes sense to wait to see if rates drop a little more.  This would be a scenario where it would take you several years to break even from your closing costs.  You may not want to spend thousands of dollars in closing costs to save $40 per month on your mortgage.

When you are calculating whether refinancing makes sense, be sure to account for the length of your loan.  Some people will compare their current payment to a new payment with a 30-year fixed.  This doesn’t make sense.  If you have 25 years left on your current loan and you refinance to a 30-year loan, your payments would be lower even if your rate stayed exactly the same.

If you have 20 years left on your loan, compare your current payments to what your payments would be on a 20-year loan.  It’s not to say you have to get a 20-year loan with your refinance, but it enables you to compare.

Now let’s say you decide that it makes sense to refinance.  The next question is what the length of the loan should be. It would typically be 30 years, 20 years, or 15 years.

You also have to decide whether to get a fixed rate or variable rate loan.  I would definitely stay away from any kind of balloon payment loan.

Unless you are planning to sell your property in the somewhat near future, I think it makes sense to lock in a fixed rate.  This is especially true now with interest rates being so incredibly low.

Liquidity and Wealth Building

So we are left with the question on how long the refinance should be.

Let’s use an example of someone who has owned a house for 10 years.  He originally took out a 30-year mortgage, and he has made his minimum payments since that time.  If he just kept his loan and made the minimum payments each month, he would have 20 years left on the loan.

Let’s say the loan is at 4%.  He can refinance to a 30-year mortgage at 3% fixed.  He can refinance to a 20-year fixed at 2.75%.  He can refinance to a 15-year fixed at 2.5%.  What makes the most sense?

You will, of course, have to look up the rates and get a quote for yourself.  But this example is pretty close to where rates currently stand as I write this.

I don’t have a clear-cut answer on what is right to do.  As with so many things dealing with personal finance, it really is personal. But there are considerations to take into account.

If you are really struggling financially, then you should probably take the longer term.  I don’t like to do this generally, but I know a lot of people are hurting right now.  Some people are facing unemployment or reduced wages because of the world we live in.  If you are really struggling, then it is better to lock in the lower payments. You can always decide to pay extra toward your mortgage later if and when your financial situation improves.

And that is the argument some people make for always taking out a 30-year loan.  You can always pay the extra amount as if you wanted to pay it off in 15 or 20 years.  But it gives you flexibility.  If you end up with an unexpected emergency like a major expense or a fall in income, then you can always go back to paying the minimum monthly payment. So I really like the longer-term loan for flexibility.

So why would anyone want to go into a shorter-term mortgage?

The answer is because not everyone needs this flexibility, or they already have flexibility because of their overall financial situation.  You may have hundreds of thousands of dollars saved in retirement accounts or even in a non-retirement brokerage account. You may have 9 months of living expenses in the bank.  Therefore, your already have flexibility and you just want to concentrate on building more wealth.

If you refinance into a 15-year mortgage, then you will likely get a lower rate.  Even if it is just half of a percent, that makes a substantial difference over time.  You will pay a lot less in interest to your lender over the course of the loan.

I think discipline can also play a role for some people.  If you go with the 30-year loan, will you take the difference and save the money?  Will you invest it or put it into an emergency fund?

To get to the heart of the matter, let’s consider an example of where someone continues to refinance every 10 years and goes back into a 30-year loan.  The monthly payments will keep going lower and lower, but there will always be payments.

If your goal is wealth accumulation, then you should also have a goal of not paying interest to lenders.  If you are a savvy investor who can continually get returns above the interest rate on your mortgage, then maybe it makes sense not to eventually pay off the mortgage due to opportunity costs.  But this is fantasy land.  There are no guaranteed returns like this for entrepreneurs and investors.

You don’t get wealthy paying interest.  You get wealthy by collecting interest.

I know there is also the factor of inflation, but even here it holds true.  Three percent interest is still three percent interest, even if it is in depreciated money.

Again, I have no clear answer on the question of what length of loan to get on a refinance. However, you should always keep your long-term goals in mind.  In this case, you want to accumulate wealth.

And that leads to the last thing regarding refinancing.  Some people take out more money in a refinance than what they owe at the time. This is a cash-out refinance.

I don’t want to say to never do it.  If you can’t put food on the table, then obviously I can’t argue with this as a method to temporarily hold you over, although maybe selling your house is a better option.  There are also rare cases where there may be an outstanding investment opportunity.  In most cases though, I think it is better to avoid doing this or you will forever have a mortgage payment.

Don’t lose sight of the ultimate goal, which is wealth accumulation.  If you can get to a point where your mortgage is paid off, it will tremendously help your cash flow, and you will be able to accumulate wealth that much faster.