There are a number of situations in which refinancing a home mortgage may make sense. For example, you may have purchased the home at a time when interest rates were much higher and you now want to take advantage of lower rates that exist today. In addition, homeowners may want to lock in a fixed rate on their mortgage if they currently have a variable rate loan and they believe that rates will rise. Or, a homeowner may just want to shorten the term of his or her loan.
Is it worth the trouble?
Refinancing can seem very beneficial, but a borrower must weigh the advantages with the costs to make sure it really is the right thing to do: the potential savings must be worth the costs of doing it.
The rule of thumb has been that you should refinance if the new rate will be at least 2 percentage points lower than the current rate. But other factors could change that – it may be worth it even with a small rate difference if certain other factors are present, but more of a break might be required in other scenarios.
There are a number of other factors that need to be considered in the “cost benefit analysis” of refinancing.
How many months will it take to break even? Here’s how to do the math
The real cost to refinancing is the closing costs. To determine how many months it will take to make up these costs with the savings from the new loan, perform this calculation:
Old payment amount – new lower payment = monthly savings
Closing costs / monthly savings = number of months to break even
Refinancing an old home loan could mean lower monthly payments and maybe changing to a fixed rate instead of a variable rate. If projected time in the house is short, any savings in payments could be consumed by the costs incurred. Also, if one plans to sell in a short amount of time a borrower may want to consider an adjustable rate mortgage (ARM) that starts out with a low rate – with plans that the house is sold and the loan is paid off before the rate can climb.
Also, consider paying off consumer debt before paying off a home loan since the consumer debt is not deductible and therefore costs more.
If it makes sense for you, please contact us at watrust.com or 1.800.788.4578 to find out how we can assist you on your mortgage financing needs.
As Vice President and Senior Wealth Advisor, Greg provides financial analysis to high net worth individuals. He is the author of several articles for various publications and nonprofit organizations on estate and financial planning subjects.