“Refinance, refinance, refinance!” That’s what everyone is saying. Yes, rates are low – maybe the lowest they’ll be. You can never tell… until they go up and you’ve missed your chance.
How can you know if refinancing is right for you? You need to ask yourself these questions before deciding:
Question 1. How long do you plan on living in your current home? If the answer is “not long” then it’s probably not worth the cost of refinancing. Do the numbers test below.
Question 2. Are you refinancing to pay off your mortgage faster or to lower your monthly payment? You really should know the answer to this question before you refinance your home. Lower monthly payments are going to look awfully tempting if you’ve got a big wish list or a tight budget. Let’s look at your options.
Let’s say you have a 30 year mortgage, but you’ve been paying on it for 10 years. That means you have 20 years left. You could refinance into a 20 year mortgage to keep the terms the same. Obviously a new 30 year mortgage would have much lower payments, but at what cost? No one wants to be paying a mortgage after retirement
Most people have heard of 15 and 30 year mortgages, but you can actually refinance mortgages in 30, 25, 20, 15 and 10 year terms. Do what’s right for your budget.
Refinancing is a long-term numbers game. Many people think that a low mortgage payment means money saved. That’s not necessarily true – it may simply mean you have more spending money this month, but you will have much less money for yourself over the next 20-30 years.
How can you tell? To find out, let’s do some math! Get out your pencil and get ready to write down some numbers.
Step 1. Take the estimated refinance principle and interest payment and subtract it from your current principle and interest payment. This will be your savings per month.
Step 2. Assume that the closing costs of the refinance will be about 4% to 6% of the mortgage amount. Example: Closing costs would be $10,000 on a $250,000 house if they charge 4%. Figure out your closing costs and write that down.
Step 3. Take the number from step 1 (your monthly savings) and divide that into step 2 (your closing costs). This is the number of months it will take you to recoup your closing costs. Example: If your refinanced payments will be $200 less your current payment, and your refinance closing cost will be $10,000, it would take you 50 months (over 4 years) to make up the difference.
Now that you know how long it will take you to recoup your costs, you should decide whether you’re going live in the house that long. If you plan to move before you can make up the difference, don’t refinance.