The math behind your decision
Should You Refinance Your Home?
by Rick Kahler
Mortgage Refinancing: Is It Right for You?
Refinancing Underwater Mortgages
Five years ago, the government was injecting trillions of dollars into the US economy. Conventional wisdom suggested that rising interest rates were soon to follow. Some even predicted the collapse of the dollar and hyper-inflation. Instead, inflation is down, the dollar is the strongest it's been in a decade, and interest rates are falling to the lowest rates we've seen in decades.
Now would be a great time to dig out your mortgage loan paperwork and consider refinancing. Here's how to find out whether it's a good option.
First, check the current interest rate on your mortgage loan. Let's assume you have a balance of $200,000, with principal and interest (P&I) payments of $1013 at an interest rate of 4.5%.
Next, begin to comparison shop. Call two or three mortgage brokers and find out the interest rate you could obtain on a new loan. They'll need to know your household income, the value of your house, and the current balance on your mortgage. If you don't know the current value of your home, you can find out its assessed value by calling or searching the website of your county Director of Equalization.
Ask the brokers to give you the interest rate and payments on a mortgage similar to the number of years left to pay on your current loan. Also ask about a shorter-term loan than your current mortgage, maybe comparing 15-year and 30-year mortgages. Usually, a shorter term has a lower interest rate. As of February 3, one local lender was offering a 30-year rate of 3.65%, with no origination fee, and a 15-year rate of 2.87%. Rates fluctuate daily, so be sure you find out the current rate.
Next get the broker's estimate of your closing costs. These will include title insurance, an appraisal, a closing fee, points, and various other fees. Lenders sometimes charge points, also known as origination fees, which are included in your closing costs. One point equals one percent of the loan's value. Mortgages described as "no-cost" or "zero points" do not carry this cost, but the interest rate may be higher, thus increasing the long-term cost of the mortgage.
Now you are ready to analyze whether getting a new loan makes financial sense. Let's assume you find out you can obtain a new loan with a similar term at 3.65%, with monthly payments of $915 and closing costs of $1,900. The new payment is $98 less than your current $1013. Divide the $1900 closing cost by the $98 monthly savings. The answer, 19, is the number of months you need to keep the house in order to break even.
If you intend to sell your home in the next two years, or if your break-even point is 24 months or more, refinancing may not make sense. Few of us know what curves life may toss us, and looking two years ahead is my comfort level.
When shopping for a new mortgage, you may be tempted to reduce your payment even more by lengthening the term of your new loan. While the benefit is more short-term spending money, the downside is many more years of payments plus paying more in points and interest. I strongly suggest obtaining a new mortgage that is equal to or less than the number of years you have left to pay on your current loan.
Remember that a lower interest rate doesn't automatically mean refinancing is in your best interest. The amount of money you save monthly, the amount of your closing costs, and how long you plan to live in your home are key variables that influence whether you should refinance your mortgage.
Take the Next Step:
- Make sure you're not overpaying on your mortgage. If you haven't looked for a lower mortgage rate in the past year, use our simple tool that compares different lenders to see what your monthly mortgage payment could be. It's private, only takes a minute and could show you how to save thousands!
- Get control of your financial life. Subscribe to Financial Independence, a free daily email that provides you with the tools to help you gain that control and achieve financial independence. Subscribers get a copy of Are You Heading for Debt Trouble? A Simple Checklist for FREE!
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