Should I Refinance My Mortgage?

Interest rates are at about the lowest level they have been in the past fifty years or so, and they literally cannot get much lower. It is natural for people to ask if refinancing their home mortgage makes sense for them under these conditions. Most people considering a mortgage refinance are looking to have lower monthly payments and/or ultimately pay less money to pay off their mortgage. If this is your motivation, then the following discussion will help you determine is refinancing makes sense for you. You might have other valid considerations, however, like wanting to get out of an adjustable mortgage and into a fixed rate loan, or perhaps you might want to switch from a 30 year mortgage to a 15 year loan to pay off your home quicker. These are certainly valid considerations, but this article will talk about whether refinancing to get a lower interest rate and lower monthly payment is right for you.

The old rule of thumb was the 2-2-2 rule, and this simple rule made a lot of sense. It says that if you have been in the home for at least two years (in other words you have built up some equity), and if the new mortgage rate is 2% below the old rate, and if you plan on living in the home for at least two more years, then refinancing makes sense.

Conditions these days are such that this rule is a bit too general for most people, so the following calculations will give you a more precise idea if refinancing is right for you.

Of course refinancing a mortgage is going to carry costs. Financial institutions don’t issue loans for free. This cost will depend on how large your loan will be, but it doubtful you can refinance your mortgage for less than about $3,000 or so. You will want to figure out how many months of lower payments it will take to pay off those costs. You can phone a mortgage broker, tell him or her you are considering refinancing, and ask for an estimate of how much this will cost in your case. They might give you a ballpark figure, or they might push you to put in a loan application. If you do this then you will receive a Good Faith Estimate of all the loan costs, as well as what your new monthly payment will be. With these you can make an accurate assessment of how long it will take to pay of the costs of obtaining the loan. Simply subtract the new monthly payment from the old and you will know how much you will save each month. Divide this figure into the costs of obtaining the loan, and the answer is the number of months to pay off the loan, or the break even period. If this is 24 months or less, there is a good chance that refinancing makes sense for you if you are expecting to stay in the home that long. Another consideration is if the new loan will prolong the payment period of your home. Prolonging the payment substantially will mean you will pay much more in interest before finally paying off the mortgage.