Refinancing your mortgage will save you money and will give you financial flexibility. Here is how to determine whether you will benefit by refinancing your mortgage:
A. The two common types of refinances are:
● Rate-and-term refinancing to save money. Normally, you refinance your remaining balance for a lower interest rate and for a term you can afford. (The term is the number of years it will take to repay the loan.)
● Cash-out refinancing, in which you take out a new mortgage for more than you owed. You take the difference in cash or you use it to pay off existing debt.
Other reason people refinance is either to replace an adjustable-rate mortgage with a fixed-rate loan or to settle a divorce or eliminate FHA mortgage insurance.
B. Breaking Even
Mortgage closing costs can total thousands of dollars. To decide whether a refinance is feasible, calculate the break-even point – the time it will take for the mortgage refinance to pay for itself.
● Break-Even Point = Total Closing Costs/Monthly Savings
Example: 20 months to break even = $2,000 in closing costs/$100 a month in savings
If you plan on keeping the house for less than the break-even time, you should probably stay in your current mortgage.
C. Mind the Term in Rate-And-Term
The formula above does not measure your total savings over the life of the new mortgage. A refinance can cost more money in the long run if you start your new loan with a 30-year term.
Example: Kris has been paying $998 a month for 10 years. If Kris doesn’t refinance, the payments will total $239,520 over the next 20 years.
After refinancing, Kris could pay $697 a month to repay the new loan in 30 years, or $885 a month to pay it off in 20 years.
$697 x 360 months = $250,920
$885 x 240 months = $212,400
D. Cash-Out Refinances
Cash-out refinances are often used to pay off debts. Imagine that you use a cash-out refinance to pay off credit card debt; On the pro side, you’re reducing the interest rate on the credit card debt. On the con side, you may pay thousands more in interest because you’re taking up to 30 years to pay off the balance you transferred from your credit card to your mortgage.