When to Refinance a Home Mortgage

September 2, 2010 No Comments »


Mortgage Q&A: “When to refinance a home mortgage.”

With mortgage rates at record lows, you may be wondering if now is a good time to refinance.

The popular 30-year fixed-rate mortgage slipped to 4.32 percent this week, well below the 5.08 percent average seen a year ago, and much better than the six-percent range seen years earlier. Historically, mortgage rates have never been lower.

So should you refinance now?

Well, that answers depends on a number of factors that will be unique to you and only you.

First, what is the current interest rate on your mortgage(s)? And what will the closing costs be on the new mortgage?  They’ve been rising lately…

Let’s look at a quick example:

Loan amount: $200,000
Current mortgage rate: 5.5% 30-year fixed
Refinance rate: 4.25% 30-year fixed
Closing costs: $2,500

The monthly mortgage payment on your current mortgage (including just principal and interest) would be roughly $1,136, while the refinanced rate of 4.25 percent would carry a monthly payment of about $984.

That equates to savings of $152 a month.

Now assuming your closing costs were $2,500 to complete the refinance, you’d be looking at about 17 months of payments before you broke even and started saving yourself some money.

So if you refinanced again or sold your home during that time, refinancing wouldn’t make a lot of sense. You’d actually lose money and that time you spent refinancing would be a bit of a waste.

But if you plan to stay in the home (and with the mortgage) for many years to come, the savings could be substantial. This “break-even” point with regard to the cost of refinancing is key to making your decision.

Sit down and determine your future plans before deciding to refinance to determine if it’s the right move.

[The refinance rule of thumb.]

What about loan term?

If you’ve already paid down your mortgage substantially, it might not make sense to refinance, as you’ll pay more interest overall if you “reset the clock.” But this isn’t always the case.

To determine if refinancing is still the right move, get your hands on an amortization calculator to see what you’ll pay in interest if you keep your mortgage intact versus what you’ll pay in interest with the new mortgage, factoring in what you’ve already paid on the old mortgage.

If your calculations reveal that you’ll pay more interest over the entire term of the refinance mortgage, one strategy to reduce both interest paid and the term of the new mortgage is to make the same monthly mortgage payment you were making before, with the excess going toward principal each month.  This will shorten the loan term and could save you a lot of money.

You may also want to look into shortening the loan term by going with a 15-year fixed mortgage.

For example, if you’re already 10 years into your 30-year mortgage, reducing the term to a 15-year fixed will ensure you don’t extend the term.  And with mortgage rates so low, you may be able to retain your low monthly mortgage payment and pay the mortgage off even earlier than expected. Also, interest rates are lower on 15-year mortgages vs. 30-year mortgages.

Other Considerations

If you’re currently in an adjustable-rate mortgage, or worse, an option arm, the decision to refinance into a fixed-rate loan could make even more sense.

Or if you have two loans, consolidating the balance into a single loan (and ridding yourself of that pesky second mortgage) could result in some serious savings.

Additionally, you might be able to snag a no cost refinance, which would allow you to refinance without any out-of-pocket costs (the rate would be higher to compensate).

A cash-out refinance could also contribute to your decision to refinance if you are in need of money and have the necessary equity.

Finally, if you’re already in a 30-year fixed and want to build home equity, you might consider taking a look at the 15-year fixed, which is pricing at a record low 3.83 percent, assuming you can handle a higher monthly payment.

Read more: 7 reasons why you can’t refinance your mortgage.

(photo: carbonnyc)

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