Does the Benefit Justify the Cost?
There are five criticial factors in your decision. Your goal for refinancing determines which are the most important.
- 1) Change in monthly payments
- 2) Change in Annual Percentage Rate (APR)
- 3) Months to Break Even
- 4) Change in Interest Rate Risk
- 5) Change in Repayment Period
1) Change in monthly payments
This is the easiest to understand and see immediate results. What size of check do you write each month? Does it get bigger or smaller?
Remember, a lower monthly payment doesn’t necessarily mean you are saving money in the long run. For example, if you only have 10 years left on your mortgage, you can reduce your monthly payments by refinancing to a 30 year loan. Your payments will drop considerably, but you will have also added 20 years to repay your loan.
2) New Annual Percentage Rate (APR)
If you want to lower your overall borrowing costs, you should focus on the APR (Annual Percentage Rate)
The ARP helps you compare loans since it accounts for both points at closing and interest rate on your loan payments. So, the APR represents the combined costs of your loan in one number.
3) Months to Break Even
You should also look at how long it takes to recover your refinance costs.
Compare months to break even with how long you think you’ll own your current home. If you think you’ll only be there for another 3 years, and it will take 50 months to break even, it probably doesn’t make sense to refinance.
How Long will it take to recover your costs to refinance?
4) Change in Interest Rate Risk
Interest Rate risk is quite simple; is there a chance that your mortgage payments will increase? And, if so, by how much?
For some people, a fixed rate mortgage, with its low risk is the best choice. For others, the low initial cost of an adjustable rate mortage (ARM) is worth the risk of increasing payments.
Do you prefer lower initial cost with higher risk? (ARM)
Or, lower risk and higher initial cost? (Get a fixed rate mortgage)
5) Change in Repayment Period
Unless you refinance to a 15 year mortgage, you will likely extend the repayment period of your mortgage.
For example, if you bought your home 7 years ago with a 30 year mortgage, you have 23 years remaining on your loan, If you refinance with a new 30 year mortgage, you will have 30 years remaining after refinancing to a new loan. This is especially important if, after extending, you will retire before paying off the loan.