How to Determine if You Should Refinance Your Mortgage
The amount of interest paid on the full term of a home mortgage can double or triple the original loan amount. The main reason to refinance is to lower the interest rate and lower the amount of interest to be paid over the term of the loan. If current mortgage rates are lower than what you are now paying, you should consider refinancing.
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Instructions
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Evaluate whether you have sufficient equity in your home to qualify for a refinance. The home must be worth at least more than the mortgage balance. Twenty percent or more equity -- home value minus mortgage balance -- is ideal. Equity of 5 to 20 percent will allow refinancing with mortgage insurance.
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2
Look up some representative current rates for home mortgages. The websites of the major national banks will provide mortgage rates for your area. Find rates for a 30-year fixed-rate loan, 15-year fixed-rate loan and a 5/1 adjustable-rate mortgage (ARM). For example, at the end of June 2011, Wells Fargo was quoting 4.5 percent for a 30-year conforming fixed mortgage, 3.625 percent for a 15-year fixed and 2.75 percent for a 5/1 ARM.
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3
Calculate the monthly payments using the current rates and your mortgage balance using an online mortgage calculator such as the one at Bankrate.com (see Resources). Using the rates from Step 2 and a $200,000 mortgage balance, the payments for the three mortgage types are:
30-year fixed: $1,013.37
15-year fixed: $1,442.47
5/1 ARM: $816.48
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Compare your current principal and interest payment amount with the payments at current rates to determine the monthly savings if you refinanced. For example, if you have a five-year-old, 30-year mortgage at 6 percent, your current payment is approximately $1,290. Refinancing to a new 30-year fixed would save $277 per month and the 5/1 ARM would save over $470.
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Estimate the closing costs for a new loan. The Bankrate.com 2010 Closing Costs study produced a national average of $3,700 for a new $200,000 mortgage and the lowest state was $3,000. As an estimate of closing costs, use $4,000 if your loan is less than $200,000 and 2 percent of the loan amount for larger loans.
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Divide the estimated closing costs by the monthly payment savings to calculate the number of months to earn back the closing costs. For the example used, $4,000 divided by $277 produces 14 months for a fixed-rate loan and nine months with the 5/1 ARM. If you plan to keep the home longer than the calculated number of months, it makes sense to refinance your loan.
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Tips & Warnings
The steps here determine if refinancing makes sense in your circumstances. Actual numbers from a mortgage lender for payments and closing costs will determine your actual savings from refinancing.
Get payment and closing cost quotes from several lenders before giving a lender any money and committing to a refinance.
Consider refinancing to a 15-year mortgage if you currently have a longer remaining term on your mortgage and the 15-year payment is near your current payment. Reducing your mortgage term by five to 10 years or more will save a large amount of money on your total mortgage cost.
If you have less than 20 percent equity in your home, a new mortgage will require mortgage insurance, increasing the monthly payment and possibly reducing the monthly savings from refinancing.
The monthly payment on a 5/1 ARM is set only for the first five years. Then the payment may go up significantly if short-term interest rates are higher at that time. Only use this type of loan to refinance if you understand what could happen to the payment after five years and you can afford a higher payment if rates do increase.
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