How to Tell Whether Refinancing is Smart
There are many circumstances when homeowners will want to refinance their mortgage. Homeowners that have taken out an adjustable rate mortgage (ARM) often will want to refinance before their mortgage resets. Homeowners that are paying higher interest rates than the current rate may want to refinance to a lower rate to save money. While in many cases, it is a smart idea to refinance your mortgage, however, it is not always the best idea. Do the math to find out whether refinancing will save you money or not.
Find Out the Closing Costs First
Most of the time, when you refinance your mortgage, you will have to pay closing costs (or roll the closing costs into the mortgage). There are home loans with no closing costs, but these have higher interest rates. Before you refinance, you should always know the terms of your agreement. Closing costs can vary, so check with your lender to see what they will be. We will use an example homeowner with closing costs of $3,000 to demonstrate how to figure out whether it will pay off to refinance your home.
Find Out The Savings
Our example homeowner has a mortgage of $200,000, and pays an interest rate of 7%. Multiply $200,000 by 7% to find out roughly how much our example homeowner is paying in interest every year. Our example homeowner is paying about $14,000 per year in interest. Divide that by 12, and we discover that they are paying $1167 per month in interest. Let's say that our homeowner was able to refinance to a lower rate of 6%. $200,000 times 6% equals $12,000, or $1000 a month. If we subtract the new rate from the old rate ($1167-$1000), we find out that our homeowner could save $167 a month on interest by refinancing.
How Long Will It Take to Pay Off the Closing Costs?
In order to find out whether refinancing will save you money or not, you have to find out how long it will take to start saving on the new interest rate. We divide the closing costs by the savings per month ($3000/$167), and we find that we will save enough to pay for our closing costs by the end of 18 months. If our homeowner was planning on moving in around a year, refinancing would not pay off. If our homeowner didn't plan on moving for a few years or longer, it would make a lot of sense to refinance your mortgage.
Refinancing Often Makes Sense
In many cases, it makes a lot of sense to refinance. If you have an ARM that is about to adjust upwards a percentage point or two, you are probably better off in another mortgage. If you love your house and want to live in it for many years, it will also make a lot of sense to refinance your mortgage. However, if you are refinancing in order to save a quarter percent off your mortgage rate, and you might land a promotion in a few years that will take you to another part of the country, you may be better off staying in your current mortgage. Do the math to see if refinancing makes sense.
