According to the Mortgage Bankers Association, Americans refinance their mortgages every four years on average, seeking for a better deal on their home loans. However, deciding whether you should refinance your mortgage is a significant decision that can have a major impact on your finances for the years to come.
Lower the Interest Rates
The rule of thumb is that refinancing is reasonable only if you get new interest rates and lower your monthly payments. New interest rates should be at least two percentage points lower, for instance from 10 percent to 8 percent, in order to save money both on monthly payments and on the balance of your mortgage. Therefore, before deciding to refinance your mortgage, it is critical to estimate the cost of refinancing, the break even period and if you are planning to stay in your home for that long.
* Refinancing Example with Lower Interest Rates
If you have a $250,000 mortgage for 30 years with a 9 percent interest rate, you payment would be $2,011.56. By refinancing at 7 percent (2 percentage points lower), your new monthly payment would be $1,633.26, so you can save $378.30 monthly.
To calculate the break even period and see if refinancing is worth, check also the closing costs of refinancing. For example, if the new closing costs are $2,500, current payments are $2,011.56 and new estimated payments are $1,633.26, then the break even period is:
Break even period = $2,500 / ($2,011.56 – $1,633.26) = $2,500 / $378.30 = 6.6 months
If you plan to stay in the house for another 6.6 months, then refinancing makes sense. If you planned to sell your house before 6.6 months, then refinancing might prove disastrous to your finances.
Change the Terms of Your Mortgage
Another reason to decide refinancing your mortgage is to change the terms of your mortgage in order to lower your monthly payments. By selecting a shorter term you may be able to build home equity quicker and save a considerable amount of money over the life of your mortgage.
* Refinancing Example with Shorter Loan Terms
On the previous example, we assume that you change your term from 30 years to 15 years. Your estimated monthly payments for your $250,000 mortgage will be $2,535.67, so you will actually pay $524.11 more every month. However, although monthly payments will be higher, it makes sense to do it if you can afford it because the total interest over the life of the mortgage will be significantly lower. In 30-years term the total interest is $474,160 while in 15-years term the estimated interest is $206,420, which makes a difference of $267,740 or 45 percent lower interest over the life of the mortgage.
To calculate estimated new payments and total interest over the life of the mortgage with refinancing, check out http://finance.yahoo.com/calculator/family-home/hom03
In conclusion, when considering refinancing, you should not only take into account lower interest rates. You should also consider bank fees, lawyer fees, appraisal and inspection fees and/or other fees that may come down the road. Refinancing at the right time can save you money, but refinancing at the wrong time can increase your debt even to the extent of declaring bankruptcy.
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