How to Calculate Refinance Savings

Calculating if the new loan makes sense.

Refinancing into a lower-rate loan can save thousands over the term of the loan. Calculating the cost savings requires knowing the exact terms of the current loan and the terms of the proposed new loan. You'll want to weigh monthly savings against the cost of obtaining the loan, and keep in mind your future plans for the property. Borrowers who plan to retire in the home and first-time homebuyers who plan to have children in the next five years must examine the savings differently.

Difficulty:

Moderately Easy

Instructions

Things You'll Need

• Current loan terms
• Proposed loan terms
• Clear future intent for the home
• Quotes from mortgage lenders

1. Obtain mortgage quotes from three to five lenders, preferably ones referred by trusted people you know. Use these quotes to determine which lender best fits your needs, and with whom you want to work. Take your time, because this decision can have a big impact on your costs and payments.

2. Compare the loan you chose with your current loan. Subtract the new payment from the current payment; this figure is your monthly savings. Be sure to compare only the principal and interest, as all other items are the same. The one exception is any mortgage insurance required by your current lender. If the new lender does not require it, that will provide substantial savings each month in addition to the amount you save with a lower interest rate.

3. Determine the cost of obtaining the loan. Use the Good Faith Estimate (GFE), a document the lender provides that outlines the costs of the new loan, and any other documents that show itemized costs of the loan. Many times the principal of the new loan will increase to finance the closing costs. Include any funds you intend to bring to closing or items you hope to finance into your new loan.

4. Divide the cost of the loan by the amount saved each month. This will determine how many months it will take just to break even with the new loan. For example, if the new loan costs $4,500 in charges, and saves the borrower $189 per month, it would take the borrower 23.81 months (4500/189=23.81) just to break even. On the 24th month, the borrowers finally save money compared to their old loan. If the borrowers are retired and plan to live in the home for five, 10 or even more years, this deal might make sense. If the borrowers are younger, plan to have another child soon and know they'll need a bigger home in two or three years, the refinance might not make sense.

Tips & Warnings

• Every situation is different, and must be treated accordingly. Don't let lenders rush you to sign applications before you are ready. Signing on for 30 years of mortgage payments requires careful consideration, and usually rates do not move so dramatically that you won't have time for a good decision.

• Do not authorize lenders to pull your credit when obtaining quotes. Each credit pull can lower your credit score by as much as 5 points. Once you decide on a lender, then fill out the applications and allow them to pull your credit at that time.

References

• Fannie Mae: Is Now a Good Time to Refinance
• Freddie Mac: Mortgage Shopping Worksheet