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Unbiased Financial Information Provided by Financial Finesse

It can be tempting to jump at the next phone call or mailer you get offering to save you big dollars by refinancing your mortgage. Many times it is a good idea, but make sure to look before you leap.

The most important concept here is how to figure out when it makes sense to refinance. There are five key factors in this decision:

  • What is the difference between your current interest rate and the new rate?
  • What is the difference between your current monthly payment and your new monthly payment?
  • How long do you plan to remain in your home?
  • What are the closing costs you must pay for the refinance?
  • How much time is left on your current loan?

You can use our online calculator to see how long you must stay in your home before you "break even" between the refinance costs and your new lower payment. After all, it doesn't make sense to drop your payment by $70 a month if it costs you $2,500 to do so and you will only be in your home for one more year. To do it yourself, simply divide the total refinance costs by the proposed difference in your monthly payment. This will give you the number of months you would need to stay in your home to break even. See the example below.

Lee has a 30 year fixed rate mortgage for $100,000 at 7%. By refinancing to a 5.5% rate, the payment will drop by $100 a month. The total cost to refinance is $2,000. Lee must keep the house for at least 20 months (2,000 divided by 100) to break even on the refinance. Thereafter, the $100 a month savings is money in Lee's pocket.

One good rule of thumb is to refinance anytime you can lower your rate by 2% or more.One good rule of thumb is to refinance anytime you can lower your rate by 2% or more, or to lock in a fixed rate if you are currently on an adjustable rate. But think twice about refinancing if you plan to be in your home less than two years - the costs to refinance may be more than the total amount you would save each month for such a short time. And it can be worthwhile to refinance for less than a 2% interest drop, but run the numbers to be sure.

If you are considering refinancing, pay attention to the total length of the loan. Using our example, if Lee has been paying on his current mortgage for five years, and then refinances for 30 years, Lee has financed his home for 35 years. If you are lowering your rate, it's best to see if you can match the remaining length of your current loan with the one you are considering (in the above example: a 25 year loan would be better than a 30 year loan).

If the numbers indicate that it makes sense to refinance, how do you choose what lender to use? Don't just go with the telemarketer that catches you the day you decide to refinance. Consider these ideas:

Get a good idea of rates in your area by using an online resource.

  • Shop around for the best rate available to you. For tips on where to begin, see A Consumer's Guide To Mortgage Refinancings.
  • Ask your current lender if they can offer you a "streamlined" refinance (which often has lower costs) - but check to see if their rates are competitive.
  • Call the credit union or bank that you use for your checking or savings accounts - they may offer better rates for current customers.
  • Consider online services that will try and find the best rate for you among various lenders.
  • Have a mortgage broker shop around for you. A broker works with a number of different lenders and can sometimes get you the best rates.
  • Make sure you compare refinancing fees and expenses as well as interest rates.

 

Once your refinance is final, confirm that the old mortgage is paid off. Then, sit back and enjoy your new, lower monthly payment!


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