Is Now the Time to Refinance?

Ok, so interest rates are falling since you took out your original mortgage, but before you jump on the “refinancing bandwagon,” understand that refinancing your mortgage will cost you time and money in order to save in the long run. Be prepared to crunch a few numbers and weigh your options and long term goals before determining if refinancing is truly in your best interest.

Number Crunching and Saving Money

The likelihood of saving money can be very good if the interest rate for your current mortgage is high. If your rate is 1.5% more than today’s rates or higher, then it is quite likely you will save money by refinancing. If you have an ARM, then you will want to compare the lifetime caps of your mortgage and today’s ARMs to determine if your rate is high enough to justify refinancing. Also, the likelihood of saving money greatly increases the longer you plan to keep the property – typically, at least five years.

The best way to determine if you will benefit by refinancing is to determine how long it will take you to recoup the costs of refinancing. Start by calculating all the costs associated with refinancing, such as points, loan fees, appraisal, title insurance, prepayment penalties, etc… For simplicity, let’s say that the total cost to refinance is $3,000 and it reduces your monthly payment by $150. At first glance it appears that you will recoup your costs in 20 months…

Be Careful – this technique is how many mortgage lenders and brokers calculate the savings to make the loan more attractive.

Please note that you will lose tax benefits as a result of refinancing. Remember, interest paid on your mortgage loan is tax deductible, therefore, you cannot properly estimate your recuperation period this way.

To properly estimate your recuperation period, you will need to know your federal tax rate. Once you know your federal tax rate you’ll reduce your monthly payment savings by that rate; for this example we’ll use 28% and reduce the $150 monthly savings mentioned above – yielding a monthly savings of $108. So if your refinance cost was $3,000 then it would take you approximately 28 months to recoup your costs ($3,000 divided by $108).

So, should you refinance?

Well, ultimately the decision is yours and only yours. Only you know your financial situation and what you are comfortable undertaking. But, as a good rule-of-thumb, if you can recoup your costs within a few years, and do not plan on moving within that time frame, then refinance.

If it takes longer to fully recoup your refinancing costs, refinancing may still be in your best interest if you anticipate keeping the property and mortgage for a long time. A recuperation period over seven years may be too risky to justify the costs and hassles. Many things can happen in that time frame – for one, rates could fall even lower.

Refinancing doesn’t have to cost a ton of money – it is possible to find no-cost refinancing or no-point loans. However, these types of mortgages may not be the best long term option, and many have prepayment penalties. Typically, the loans that yield the lowest interest rates require you to pay points. These may require greater up-front, out-of-pocket expenses, but you will benefit significantly in the long run.

Depending on your circumstances, some loans will allow you to amortize your expenses over the term of the loan. Carefully investigate this option, as it may not provide the greatest overall benefit and you may be required to pay interest on the amortization. If your overall goal is to simply lower your cash flow, then this may be an option. However, keep in mind that this approach may not have the same benefits in the long run.

Anyways, if you have decided that refinancing works for you, then make sure you shop around. Also, check your existing mortgage to make sure you will not be charged a prepayment penalty – or at least find out what it may be so that you can factor it in with your costs.

As you should now realize, the amount you save is going to be greatly affected by your costs, and every lender and broker has varying fees. So be sure you ask all the right questions regarding the costs to you, and heed caution if someone says that there are “no” costs to you. Remember, nothing in life is free, especially mortgages.