by Matt Frankel, CFP | Updated July 19, 2021 - First published on Aug. 9, 2020
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Here's how to tell if refinancing makes good financial sense.
With mortgage rates at record lows, refinancing your mortgage right now might seem like a no-brainer. And for millions of American homebuyers, that certainly may be the case -- in fact, I'm currently shopping around for a refinancing loan for my own home.
However, there's more to consider when it comes to refinancing than just the interest rate you can get on a refinancing loan. Here's an overview of how to tell if refinancing could be worth it for you, as well as some of the other factors you should consider before filling out an application.
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The key point to know before you start the mortgage refinancing process is that refinancing isn't free. Lenders charge origination fees when you want to refinance, and there are also several other common types of closing costs like title insurance, appraisal fees, and credit report fees. These can vary dramatically: The cheapest option I found in my recent refinancing application came to about $1,600 to close.
So the key question to ask is whether the savings you achieve on your monthly payment will justify what you're paying to refinance. This is known as the breakeven calculation, and here's how it works:
Here's why this matters: If you'll live in the home for longer than it takes to break even, refinancing could be a smart idea. If not, it's probably best to stick with your current mortgage.
It's also worth noting that you can perform this breakeven analysis several times if you shop around for more than one rate quote for refinancing (which you should certainly do).
Let's take a look at how this works. We'll say that you still owe $250,000 on your mortgage and that you're currently paying $1,325 per month for principal and interest. You obtain a quote to refinance into a new 30-year fixed-rate mortgage at an APR of 2.875%, and this would result in a monthly payment of $1,038. However, it would cost a total of $3,600 to close on the loan.
To calculate the breakeven point, first subtract the new mortgage payment of $1,038 from the current $1,325 monthly payment, a difference of $287.
Next, divide the $3,600 in closing expenses by $287, which gives you 12.5. (Note: Always round this up to the nearest whole number.)
This tells us that our refinancing savings will outpace the cost of obtaining the loan in just 13 months. That's why this is such a good environment to refinance a mortgage for so many people.
In addition to the breakeven analysis, there are a few other things to consider before deciding to refinance:
There's no one-size-fits-all answer to whether you should refinance. But if you use the breakeven calculation above and take some of the other potential reasons to refinance into account, you'll be in a good position to make the right decision for you and your family. And with mortgage rates at all-time lows, if refinancing makes good financial sense for you, now could certainly be a smart time to do it with the right refinance lender.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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