What Is the Biggest Factor in Home Refinancing?
Specific factors used in making a home refinancing decision can vary based on the particular goals you have with refinancing your mortgage. However, as a general rule, refinancing makes the most sense when a lower interest rate produces significant enough savings to justify your upfront investment in mortgage closing costs.
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Refinancing Basics
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Mortgage refinancing is the process of getting a new mortgage loan that pays off and replaces your existing loan. You can refinance through your existing lender or through another bank or lender. Typically, when people refinance, they do so to get a lower interest rate, which leads to reduced interest expenses over the loan repayment term. Reducing monthly mortgage payments is another reason homeowners may look to refinancing. Spreading your repayment back out to 15 or 30 years inherently lowers your monthly installments if you have paid off some of your existing loan.
Investment Decision
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Homeowners often do not think of refinancing as an investment, but that is essentially what you do when you refinance. You invest money in closing costs to save money over the course of your loan. In essence, it is a debt investment. Advisers often encourage homeowners to weigh the return on investment of a refinance decision in the same way you would other investments. If refinancing saves you less money than you could make investing closing cost money in something else, you might choose not to do it.
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Break-Even Formula
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One of the first steps a mortgage consultant does with refinancing candidates is determine a break-even point on a refinance decision, points out "Lending Tree". You can actually do this yourself using one of many online refinance calculators available on banking websites. A bank consultant can tell you how much your potential monthly mortgage payment is with a new loan. Compare this with your existing monthly payments to determine your savings. Then, estimate your closing costs, which a lender should confirm with a Good Faith Estimate. Divide the potential savings into the closing costs to figure out how many months it will take to recoup your investment and begin making money from your decision. Generally, if you intend to remain in the home longer than it takes for your savings to cover the investment, refinancing makes sense.
Other Considerations
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The simple formula is a solid starting point in considering whether to explore refinancing further. It leaves out some important considerations, though. Even though a refinance can save you interest, the real savings is slightly offset by lost tax deductions on the lower mortgage interest. You may also have a prepayment penalty on your existing loan which can significantly restrict refinancing benefits. This fee is typically equivalent to few month's interest payments, or a small percentage of the remaining loan balance. Finally, "Lending Tree" suggests you consider options for including closing costs in the new loan principal. Some lenders even cover closing costs with a slightly higher rate. If the new rate is lower than your existing rate and eats up the closing costs, refinancing most likely makes sense.
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