Homeowners have different reasons why they refinance their mortgage. Many are prompted to apply for a new loan because of lower interest rate. Some are changing from adjustable rate to fixed rate. Others want to tap the equity of their home for home improvement, take a vacation or pay for college tuition.
But whatever it is, mortgage refinancing provides an opportunity to save money. But how will you know if you can really save by refinancing your current loan, and if the savings you will get is worth the cost?
The following steps provide a guide in evaluating your current mortgage loan:
1.) Examine your current loan. Interest rate is the most significant (but not the only) factor that influences your monthly mortgage payment. Check the rate you are paying and compare it to the current rate offered. If the current is low, is it low enough that you can actually save on monthly payments? As a rule, consider refinancing if the current rate is 2% lower than that of your current loan.
Is your rate fixed or adjustable? If it is fixed, then it is easier to determine if it is right to refinance, but you have to consider other factors too. If it is adjustable, determine the movement of your monthly payment when rate changes. Your loan documents have this information. If this is not clear to you, your financial advisor can explain whether it is wise to refinance.
2.) Compare the current interest rate with your loan’s interest rate. It is clear to see that a 2% drop on interest rate would mean hundreds of dollars worth of savings on monthly mortgage payment. For example, a $200,000 mortgage with a 30-year term at 8% interest would equate to a monthly fee of $1,467. The same mortgage with 6% interest would only require you to pay about $1,200 a month.
This is just a rough calculation as there are specific factors that need to be considered when determining you rates such as your credit score and loan-to-value ration. Also, factors such as points that you pay upfront and other fees determine the actual monthly savings you can get. Don’t assume, therefore, that as long as you refinance on a lower rate, you will get the savings you expect.
3.) How long are you going to stay in your home? Among all other issues, this could be the question that will determine whether you need refinancing or if you are going to save after all. Think of it this way, taking another loan even if you plan to move after a year or two would only mean spending more on fees than really getting the savings you are gunning for. As a rule, remember this: the longer you plan to stay in your house, the more it makes sense to refinance your mortgage.
4.) Determine the break-even point. Computing the break-even point is simple: know the total cost you have to pay upfront when you refinance. Then, find the difference between the monthly mortgage of your new loan and your first loan – that would become your monthly savings. Divide the cost of your loan with monthly savings to get the number of months before you reach the break even point.
So if you purchase the loan for $4000 and you will save $100 a month, it will take you 40 months or 3 years and 4 months to recoup the cost of the loan. On the 41st month, that’s the only time you begin to get the savings.