Does It Make Sense to Refinance?

When Does It Make Sense to Refinance Your Mortgage?

It seems like an easy question. However, in reality, you could have a difficult time answering it properly. First, you should know how long you plan on living in your house. Then you should ask yourself why you want to refinance your current mortgage loan. Usually, this question has three possible answers:

1.Increase payment predictability by replacing, for example, an adjustable rate mortgage loan with a fixed rate mortgage loan.

Refinancing to a fixed rate mortgage will allow you to know in advance the amount you have to pay each month. In addition, your payments will not be influenced any more by factors you cannot control such as economic trends, or indexes used to calculate your adjustable mortgage rate (AMR).  Most lenders use the following indexes when calculating a floating interest rate:

• 1-year Constant-Maturity Treasury Securities (CMT),
• Cost of Funds Index (COFI),
• London Interbank Offered Rate (LIBOR).

2. Improve your cash-flow by reducing the monthly payments towards your mortgage loan

This decrease in monthly payments usually happens when you refinance for a longer term, for example, you take a 15-year initial mortgage loan and you refinance into a 30-year mortgage loan.

If you choose to refinance into a longer term your monthly payments will decrease but your total costs with the loan will dramatically increase. So, make sure this is the right decision, for a small reduction in monthly payments may transform into tens of thousands added to the total cost of your loan.

Also take into consideration that each time you refinance you in fact take a new loan and when contracting a new loan, you pay more towards your interest and less towards the principal. To calculate in detail how much interest you owe, check websites such as www.bankrate.com.

3. Reduce the overall cost of the mortgage loan, when market interest rates have dropped in the marketplace.

Make sure, when you crunch the numbers to see if you go beyond the break-even point when refinancing, that you take into consideration the closing costs. These costs are an important part of the overall picture, so don’t dismiss them as not important. When doing the math, calculate how long it will take you to recoup the money you spend on closing costs, assuming your monthly payment decreases. All you have to do is divide the total closing costs by the monthly savings to figure out the number of months you need just to break-even.  If you plan on staying in the house longer than the breakeven point, you will save money by refinancing.  If you do not plan on staying in the house until the breakeven point, re-financing will end up costing you money.

If you get a loan with “no closing costs”, you still pay these fees, but instead of paying them as an upfront lump sum, you will pay a little bit extra each month. Make sure to compare “apples with apples” when you crunch the numbers, for your monthly payment might have been higher just because you had a so-called “no closing costs loan”, with the payments included in your monthly installments.

In conclusion, there is no one good answer to the question “Does It Make Sense to Refinance?” It depends on your particular situation, how long you plan on living in the house, and what factors you consider to be most important.