Should you refinance a small mortgage with a high interest rate?
Anytime you can lower your interest rate by refinancing your mortgage it usually makes financial sense but the analysis is more complicated with a smaller loan for multiple reasons.
First, a relatively small number of lenders offer mortgages below $50,000. Because fewer lenders offer small mortgages, the loan terms can vary widely. In some cases lenders may charge higher origination fees or closing costs for smaller mortgages, especially as a percentage of the loan amount.
For example, if you pay $2,000 in closing costs on a $100,000 mortgage, the costs represent 2% of the loan amount. If you pay $2,000 in closing costs on a $40,000 mortgage, the costs represent 5% of the loan amount, which is very high.
So if you want to figure out if you should refinance a smaller mortgage, you need to make sure that the closing closing costs are justified by a lower monthly payment. You can do this by determining how long it takes to recover your closing costs.
Returning to the example above, if you pay $2,000 in closing costs and you save $50 on your monthly mortgage payment by refinancing, it takes 40 months, or three years and four months, to recover the costs ($2,000 (closing costs) / $50 (monthly savings) = 40 (months). You usually want to recoup your closing costs in 30 months or less when you refinance.
Use ourMORTGAGE REFINANCE CALCULATORto determine your monthly savings and how long it takes to recover your closing costs
So the answer to the question of if you should refinance a small mortgage comes down to the closing costs. If you can lower your mortgage rate and pay no or low closing costs then refinancing makes sense.
If you are required to pay higher closing costs because your mortgage amount is small or for another reason, then you need to determine if you recover the costs within a relatively short time frame. This is particularly important if you intend to sell your home or pay off your mortgage sooner rather than later.
If you decide to refinance, we recommend that the length of your new loan matches, or is shorter than, the number of years you have remaining on your current mortgage, if possible. For example, if you have ten years remaining on your current mortgage, you should refinance into a new ten year loan.
If you refinance into a new loan with a longer term, such as replacing an existing 30 year mortgage with a new 30 year loan, you effectively extend the length of your original mortgage. Adding another five or ten years to a mortgage can increase your total interest cost significantly.
The table below shows refinance rates and fees for leading lenders. We recommend that you contact multiple lenders to confirm their minimum loan amount and to compare refinance terms.
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If you are finding it challenging to find lenders that offer small mortgages we recommend that you contact local credit unions, banks and community lending institutions. Community-based lenders, and credit unions in particular, may offer the smaller mortgage amount you may need.
You can use the FREEandCLEAR Lender Directory to search for lenders by type, loan program and location. For example, you can search for top-rated credit unions in your state to determine their minimum loan amount.
The final option for refinancing a small mortgage is to use a home equity loan or HELOC. These programs typically permit much smaller loan amounts and you may still be able to lower your interest rate and monthly payment.
The closing costs for a home equity loan or HELOC are also usually lower than for a refinance. As long as these options allow you to refinance your entire mortgage amount, they may provide greater financial flexibility and save you money in the long run.
The table below shows home equity loan and HELOC terms for lenders in your area. Shop several lenders to determine the program that best meets your needs.
Sources
"Determining Whether to Refinance." My Home by Freddie Mac. Freddie Mac, 2019. Web.
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