Refinance Math: The Three Areas to Look for Savings
Current home interest rates are at nearly an all-time low, and it might seem like there’s never been a better time to refinance your home loan. But despite the irresistible potential for savings, the math needs to work out in your favor.
Simply put, it’s not just a matter of comparing the refinance rate with your current mortgage rate.
Once you actually apply for a home mortgage refinance, you can calculate exactly what you’d be spending or saving by refinancing your mortgage. You can factor in closing costs and fees, and upfront payments. And any reputable home lending company will happily help you run the final, thorough calculations, in order to make sure you’re getting a deal that benefits you (if they won’t, they’re just not worth your time and money—no matter how good their refinance rates might seem).
But for a basic idea, here are the three areas to examine and understand whether or not refinancing your home would be a smart decision:
1. Monthly Savings
This one is pretty simple: Figure out what you’ll be paying each month after refinancing. Subtract that from what you’re currently paying—or, if you currently have an adjustable-rate mortgage, what you’re expecting to pay after the loan balloons. (Don’t forget to leave room for closing costs and other fees, which will vary depending on your financial picture and credit history, and where you apply for your refinanced loan.)
If, thanks to the lower interest rates, the monthly payments will be lowered, refinancing might be a great idea. Congratulations.
However, some homeowners actually choose to pay more each month as a way to switch from a less stable adjustable-rate mortgage to a much more secure (but slightly more expensive) 15-year or 30-year fixed-rate mortgage. Also, some folks will take higher monthly payments (coupled with lower interest rates) in order to significantly lower the total amount of interest they’ll pay when everything is said and done.
If this situation applies to you: Can you handle that increase? Are the long-term savings and peace of mind worth tighter month-to-month budgets?
2. Shorter Loan Terms
Let’s say your current monthly $1,000 payment is as much as you can afford. But with the lower interest rates available, an identical $1,000 per month (including costs) will knock out the principal much, much more quickly. So while you won’t see a month-to-month difference, you’ll be payment-free years before you would without a refinance. And for every month you don’t have a principal payment, that’s money saved on interest.
Taking a long-view can also reveal how you might lose money on a refinance.
For example, if you’re hoping to move in the next few years (say, when the local housing market improves), the monthly savings might not catch up to the initial closing and refinance costs you pay up front.
There’s an easy calculation to figure out if this will be a risk: Divide the total costs to refinance (fees, etc) by the amount you’re saving each month. If it takes, say, 24 months to pay off the initial costs with the monthly savings, and you’re not planning on staying in your home for that long, you might end up losing money on the refinance.
3. Potential Reinvestment Earnings
Looking at the big picture, it’s not a bad idea to consider (very cautiously) the money that could be made by reinvesting the savings.
For example, if you save $200 on your monthly payment, that’s $200 to invest monthly in home upgrades, your business, or any other sound investment. Similarly, the money saved on the back end is freed up to invest in whatever makes most sense to you.
It’s probably not a good idea to make long-term concrete plans on money that might be made. And if your decision about whether or not to refinance hinges mathematically on this, it’s probably better to take the safe route. But, still, it’s an added refinance benefit that should not be ignored.
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Categorised as: Refinance