Dubai: Let’s say you are approaching retirement with minimal savings in hand, due to which you hope to refinance your house to make ends meet post retirement. This has been the trend in recent years, as indicated by global studies, so there is a need to weigh whether this is a smart money move.
Lower mortgage rates can save you hundreds of dirhams on your monthly payments. Refinancing your mortgage to a new one with a lower rate would then seem to make sense.
But what if you're approaching retirement? Is refinancing a smart move when you're planning to leave the workforce in five years or less? The answer depends on your unique financial situation and your goal from a refinance.
To refinance or not to refinance?
If your main goal is to reduce your monthly costs, refinancing might make sense. But if you plan on moving from your home shortly — in, say, less than five years — then a refinance might not be the best option.
That's because refinancing a home loan isn't free. The typical refinance costs thousands of dirhams — money that you'll usually roll into your new loan amount and pay off over time when you make your regular monthly payments.
It might take you several years to save enough money each month to recover the closing costs. If you're moving too soon (and surveys show that retirees often move from their homes sooner than they originally planned), you might not generate enough monthly savings to even pay back those initial closing costs.
Need to first consider the time factor
Then there's the time factor. A refinance, unless you are reducing the term of your loan at the same time, means that you'll be paying off your mortgage for a longer number of years. As a retiree, you might instead prefer to pay off your current mortgage in a shorter amount of time.
One consideration is the length of the term on the new loan. When people refinance their mortgage, they are re-setting the loan term and essentially starting over again.
As an example, if you are paying off a 30-year fixed-rate mortgage that you have been making payments on for 15 years, you'll have an additional 15 years left to pay off that loan. If you refinance that loan to a new 30-year one, you've just increased the lifespan of your mortgage by another 15 years.
The questions you need to ask yourself is: Do you want that monthly payment hovering over you for another 15 years, even if refinancing will result in immediate monthly savings?
That's not an easy question to answer, especially when you consider how much of your payments on a new mortgage loan, even one with a lower interest rate, will go toward interest instead of principal.
The first few years of mortgage payments on a new loan are designed to go toward the interest, and less towards the principal. As the years go by, more of the monthly payments go toward the principal, and less toward the interest, so matter experts say this is another important consideration.
Next, understand what the numbers indicate
It's important for every homeowner to crunch some numbers before deciding to refinance. But it's especially important for those nearing retirement who might need to recover their refinancing closing costs in as few months as possible.
Let’s say you owe Dh150,000 on a 30-year fixed-rate mortgage with an interest rate of 5 per cent. Your monthly payment, not including insurance, will be about Dh805.
If you refinance that same amount to a 30-year fixed-rate loan with an interest rate of 3.95 per cent, your monthly payment will drop to about Dh711 a month — a savings of about Dh94 a month, or Dh1,128 a year. That sounds good, right? But remember, refinancing can be expensive.
Let’s assume refinancing that Dh150,000 amount, costs Dh4,500 in closing fees. It will take you almost four years to save enough from your refinance to pay back these closings costs. Is that worth it? If you stay in your home for eight years or more, it might be. If you end up moving in five years, it might not be.
However, let’s say you owe Dh200,000 on a 30-year fixed-rate loan with an interest rate of 5 per cent. Then your monthly payment, again not counting insurance, would be about Dh1,073.
If you refinance that Dh200,000 to a new 30-year fixed-rate loan but at an interest rate of 3.95 per cent, your monthly payment would fall to about Dh949 a month. That's a savings of Dh124 a month, or Dh1,488 a year.
If your loan closing cost that same Dh4,500, it would take you just a bit more than three years to generate enough savings to pay for your closing costs. That shorter time frame might make it more worthwhile for homeowners nearing retirement.
One last factor to consider to help you decide
There is another factor to consider. If you'll absolutely need to reduce your monthly living expenses after you retire, then refinancing might make sense, even if it will take you longer to recover the costs of closing.
From a global perspective, many who retire typically see their retirement income fall to nearly half of what they earned while they worked full time, multiple research show.
This, according to property consultants, is one of the considerations borrowers should account for when making a decision about refinancing.
Will they be able to afford the monthly payments associated with the mortgage, insurance (and property taxes, if it applies to your country) on their retirement income?