When does it pay to refinance a mortgage?

It seems as though every time you look at the financial news, mortgage rates are hitting "all-time lows." Does this mean you should pull the trigger and refinance your home loan? What if you refinanced last year?

Bragging rights is not a good enough reason

There is no rule against refinancing as often as you please; however, the expense involved means that you shouldn't chase the lowest mortgage rates at all costs. Refinancing to outdo everyone else at cocktail parties is silly. You want to refinance when you can recoup the costs of refinancing fairly quickly, that is, when the monthly interest saved is sufficient to pay for the lender and third party charges associated with the mortgage refinance.

Understand "savings" calculations

The quick-and-dirty way to determine if refinancing makes sense is the "break-even" calculation. Here's an example:

Christine has a five-year-old $350,000 mortgage at five percent. Her remaining balance is $321,401 and her payment is $1,879. She discovers that she can refinance at four percent, at a cost of $6,482, which she chooses to wrap into the new loan, so her refinance loan amount is $327,883. She enters these numbers into the refinance calculator. Her new payment is $314 less than her old one.

It takes one year and nine months to recoup the cost of refinancing with the lower monthly payment ($6,482 divided by $314). However, a substantial part of that savings is just the result of stretching the remaining balance over a new term, taking 35 years total to pay off the mortgage.

In fact, if you use the mortgage payment calculator and view the amortization tables, you’ll see that Christine would pay a total of $676,395 if she left her mortgage alone and continued to pay a five percent rate. And if she refinances the $327,883? She already paid $112,735 in the first five years of her current loan. Add the $563,531 for the new 30-year loan and you get a total of $676,266.

Total savings? A whopping $129. But wait; there’s more.

Turbo-charge your refi savings

The previous example assumes that Christine takes her monthly savings and uses it to buy shoes or take vacations. But what if she uses it to pay her mortgage off in 25 years instead of 30? Her 25-year payment at 4% is $149 less than the original $1,879.

And her total paid is $631,939, a savings of over $44,000. And she gets an extra $149 a month to spend on shoes and vacations!

The no-brainer refinance – when it always makes sense

Any time you can get a no-cost refi with a lower interest rate, go for it--you have no break-even period, so the savings go straight to your bottom line. You can invest it, pay down your debts, or accelerate your mortgage payoff.

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