You hear interest rates dropped so you immediately assume that you should refinance. What if it doesn’t make sense, though? It takes more than a lower interest rate for refinancing to make sense. Since getting a new mortgage costs money, you need to make sure it makes financial sense to refinance.
Keep reading to learn how to tell if refinancing makes sense for you.
Will Your Monthly Payment Change?
First, look at your monthly payment. How much will it change? Just because you can get a lower rate doesn’t mean your monthly payment will change all that much. Ask for the principal and interest payment amount to determine your savings.
Whether or not you will save money depends on three things:
- The amount being financed – How much of your principal balance have you paid down? Are you refinancing the outstanding principal balance or will you take out some of the home’s equity? If you increase your loan amount, your monthly payment may increase or won’t decrease as much as you thought.
- The interest rate – If your goal is to lower your payment, you’ll need a lower interest rate. Typically, saving 0.5% or more on the rate helps decrease your payment sufficiently.
- The term – If you lower your term, your payment will increase only because you’ll pay more principal with each payment. If you take a longer-term, though, you’ll pay more interest over the life of the loan.
Think about what you want out of your monthly mortgage payment. Do you want a lower payment? If so, focus on the interest rate and choose a longer-term. If you would rather pay your principal down faster, choose the shorter term, but expect a higher payment.
How Much Will You Save?
Next, look at how much you’ll save on your monthly mortgage payment. The calculation is simple:
Original payment – new payment = Monthly savings
The monthly savings will play a role as we figure out your break-even point.
What are your Closing Costs?
Next, you need to know the amount of the closing costs. Like we said, every refinance loan has closing costs. How much you pay determines your break-even point or point when you repay your closing costs and start reaping the savings from the refinance.
Your lender should send you a Loan Estimate within three business days of closing on your loan. The Loan Estimate shows the total closing costs or estimated closing costs. Use this figure in the next step.
The Break-Even Point
Now, let’s put it all together. The break-even point calculation is as follows:
Total closing costs/Monthly savings = Break-Even Point
Here’s an example:
Your total closing costs to refinance your loan are $4,000. You will save $100 per month with the new, lower interest rate. Your break-even point will be:
$4,000/$100 = 40 months
It will take 40 months of payments on the new loan before you start realizing the savings. In other words, for the first 3 ½ years, you won’t save anything with the new loan. Yes, you’ll have a lower mortgage payment, but you had to pay out $4,000 to get that lower payment.
Now you must think of your plans. Will you be in the home for much longer than 40 months? If you won’t, refinancing doesn’t make sense. You’ll probably spend less money paying the higher mortgage payment for the time you have left in the home.
On the other hand, if you will be in the home for the long-term, say you have a 20-year plan, then you’ll more than make out on the deal. After the 40 months, you’ll save $100 a month or $1,200 per year. The savings can add up fast.
Before you refinance, really look at the numbers. Don’t fall for a lower interest rate and assume you’ll save money. Instead, look at the big picture. What will it cost you to get that lower interest rate? Is it worth the money you must pay out of pocket? If you won’t realize the savings before you move or you won’t enjoy them for a long time, keeping your current mortgage may be the best bet.Click to See the Latest Mortgage Rates»