How to Refinance Your Mortgage and Lower Your Monthly Payments
If you are a homeowner who was lucky enough to buy when mortgage rates were low, you may have no interest in refinancing your present loan. But perhaps you bought your home when rates were higher. Or perhaps you have an adjustable-rate loan and would like to obtain different terms. If you do refinance, the process will remind you of what you went through in obtaining the original mortgage. That's because, in reality, refinancing a mortgage is simply taking out a new mortgage. You will encounter many of the same procedures-and the same types of costs-the second time around.
Would Refinancing Be Worth It? Refinancing can be worthwhile, but it does not make good financial sense for everyone. For a long time, the general rule of thumb was that refinancing was worthwhile if the current interest rate on your mortgage was at least two percentage points higher than the prevailing market rate. This figure was generally accepted as the safe margin when balancing the costs of refinancing a mortgage against the savings. The theory was that it took at least two years to realize fully the savings from a lower interest rate, given the costs of the refinancing. However, today many lenders offer "no cost" refinancing, which changes the old rule of thumb. Now, homeowners might want to conisder refinancing even if the rate is 1 or 1.5 points lower.
How do you know if you will save money by refinancing? If you plan to stay for a long time, then you should definitely refinance. Doing so could potentially save you tens of thousands of dollars. If you plan to move in the next few years, you could refinance, but accept only a loan that comes with no points or closing costs. Of course, such a deal with be higher than the traditional type, but it is almost always going to save you money. (The costs are included in the higher interest rate.) Most sources say that it takes at least two years to realize fully the savings from a lower interest rate, given the costs of the refinancing. (Depending on your loan amount and the particular circumstances, however, you might choose to refinance a loan that is only 1.5 percentage points higher than the current rate. You may even find you could recoup the refinancing costs in a shorter time.)
You don't actually save any money until you have reached your breakeven point which is as follows: Old monthly payment minus new monthly payment divided into the total cost of refinancing. The result is the number of months it will take you to reach your breakeven point.
Once you break even, your savings can be significant. Just a two interest point decrease can reduce monthly payments significantly and save thousands over the long term. To illustrate, on a $100,000 30 year mortgage, a 7% interest rate would require a $665.30 monthly payment and a 9% rate would require a $804.62 monthly payment. If you plan to stay in your house for a very long time, paying an extra $139.32 adds up. Over ten years, that means wasting an extra $16,719 that could have been invested in a retirement account.
What Are the Costs of Refinancing? The fees described below are the charges that you are most likely to encounter in a refinancing. Estimated expenses of refinancing are about three to six percent of amount borrowed. Use our Mortgage Refinancing Calculator to determine the best option.