How to Calculate Whether to Refinance
When you calculate whether to refinance your current mortgage, consider your long-term financial goals, as well as how long you plan to stay in your home. Obtaining a lower interest rate with a refinance can save you thousands of dollars over the life of the loan. Current interest rates and potential closing costs of getting a new loan should be factored into your decision.
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Considerations
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According to Michael Beriss, a senior financial adviser with consulting firm Ameriprise Financial, the easy part of your decision is determining the importance of interest rate fluctuations. If you currently have an adjustable-rate mortgage (ARM) and interest rates are rising, you should take notice. A rise in rates means an increase to your monthly mortgage payment; you may want to consider refinancing for a fixed-rate loan. If you already have a fixed-rate mortgage, you may want to calculate whether to refinance when interest rates are dropping.
Costs
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Closing costs are the biggest expense associated with refinancing --- this expense can range from a couple thousand dollars to more than $10,000. Once you know how much the chosen lender charges for closing costs, determine how many months it will take to recover the fees with new monthly mortgage payment savings by dividing the closing costs by the monthly savings. There are numerous mortgage calculators available online, in which you can plug in the loan amount and term, along with the interest rate, to determine your expected monthly payment.
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Timing
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A premium time to refinance a fixed-rate mortgage is when you can qualify for an interest rate that's at least 2 percent lower than your current rate, which means fewer months to make up the closing costs. Anything less than a 2 percent difference may only be worth the costs of refinancing if you plan to stay in your home for many more years.
Goals
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Take into account your financial goals when you calculate whether to refinance. You may want to refinance for reasons other than getting a lower interest rate and monthly payments. Shortening the term of your loan, such as going from a 30-year loan to a 15-year loan, may be in line with your goal of reducing the total amount of interest paid over the life of the loan. If you have more immediate financial concerns, you may opt for a cash-out refinance to pay bills or remodel your home.
Shop
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As you probably did with your original mortgage, shopping around for the lowest interest rates and closing costs is a prudent first step in the refinancing process. Your current lender may not offer you the lowest possible rate, since it loses profits by doing so. An alternative lender may be more eager to earn your business by offering a more cost-effective deal.
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