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Does it Pay For Me to Refinance My House? 3 Factors to Consider
Anyone who follows financial news notices times when mortgage rates appear to have moved downward, meaning that the average mortgage rate today is likely to be lower than it was 6 months or a year ago.
It’s during these times that we wonder if we’re missing out if we don’t refinance our home to take advantage of better interest rates.
The answer comes down to a simple question that answers the question: will refinancing my house cost me more than I save?
Know when to refinance
If you’re asking, “Is it worth it to refinance my house?”, you just need to do a little math. Don’t worry, it’s pretty easy.
The easiest way to figure it out – the one most people use – is a “roughly correct” rule of thumb, which can give a slightly inaccurate result. This rule of thumb is to divide the reduction in your monthly mortgage payment (with the new loan) by the cost of the refinance.
For example, if your new, post-refinance payments are $100 less than your current loan and the refinance will cost you $2,000, you’re better off refinancing if you plan to live in your home for at least 20 months ($2,000 / 100 = 20).
The problem with this calculation is that it doesn’t take into account that your old and new loans are paid off at different rates.
How to calculate the return on refinancing: 3 factors
To calculate whether your home should be refinanced more accurately, you need to consider three factors:
1. Difference in your monthly payments (old vs. new loan)
2. The price of the new loan
3. Difference between outstanding loan balance after some months like 10 months (old vs. new loan)
For example, let’s say you want to know, “Is it the case that if I refinanced my mortgage now and lived in my home for at least 10 months, how much would I have gained or lost on the refinance?”
To find out the answer, first determine the difference between the monthly payments on your old loan (current loan) and your new loan. Let’s say it’s $100. Then figure out how much your loan would cost (be sure to include all closing costs such as points paid, title fees, etc.). Let’s say this number is $2,000. So let’s say you use a mortgage calculator and find that with a new loan, your remaining loan balance in 10 months would be $1,100 less than if you kept your current loan.
In that case, your 10-month net savings/refinancing costs are calculated as follows:
a. savings in monthly payments in month 10: ($100 savings x 10 months) = $1,000 savings
b. Loan price: $2,000
c. lower balance in month 10: $1,100 lower loan balance
The result is calculated as follows: ($1,000 + $1,100) – $2,000 = $100. This means that refinancing will result in $100 in savings.
So we can see that in this case the break-even came in about month 10 (which is the number we happened to try), not month 20, as we had calculated using a rule of thumb that ignores the difference in loan balances. tip: try different monthly periods to see how the answer changes.
Use this simple calculation method to determine if your home is worth refinancing.
Of course, for the calculation to work, you’ll want to get quotes from at least 2-3 lenders so you can get them to determine your new monthly payments for a potential loan, which you can factor into the equation.
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