Does It Pay for Me to Refinance My House Now?

If you contact your bank inquiring about a mortgage refinance, they will probably bend over backwards to help you refinance your loan. Why? Two potential reasons:

a. they stand to make money in the form of closing costs that they would receive during the closing process

b. they know you are looking to refinance and they would rather that you do the loan refinance through them instead of going with a different financial institution

Still, just because your bank is totally supportive of the idea of your proposed house refinance does not necessarily mean you should be. You will need to ask yourself some questions and be prepared to answer them in a straightforward, honest way. The good news is that it is not hard: you can come to the right decision after doing less than 1-2 hours of homework.

The main factors that you should take into account when deciding whether you should refinance your home right now are the following (not necsessarily in order of importance):

1. The length of time you plan to remain in your current home: generally, the longer you plan to stay in your home, the better an idea it is to refinance.

2. Whether you current mortgage is a fixed or adjustable rate mortgage (ARM): if you currently have an ARM whose fixed interest period has just expired, your payments may have just shot through the roof.

3. The situation with average mortgage interest rates: if rates on average are down as compared to when you took out your current loan, it may make sense to apply for a refinance loan.

4. Whether you have time to really shop for the best refinance deal: comparison shopping is the best way to secure the lowest-possible rate. If you do not have time to do so right now, consider waiting a few more weeks or months.

5. Your current credit score: if your score has improved since you took out your mortgage, that is a potential sign that you could qualify for a lower rate.

6. Your equity situation: if you want to cash out some of the equity in your home to pay off higher interest debts, a refinance may make sense.

7. Your home's value: if your home is worth the same or more than it was when you took out your current loan, that is a potential reason to refinance.

When you refinance your loan, you will likely incur some closing costs. However, in the long term, most refinance situations result in the mortgage holder paying a lower amount of interest each month. Eventually, the amount you save in interest due to the new loan will surpass the amount you paid in closing costs. This number, expressed in months, is the breakeven point.

There are various formulas for figuring out your breakeven, each with its own advantages and disadvantages. However, the simplest, back-of-the-envelope way to calculate your breakeven is the interest savings calculation. This is simply the number of months it will take for your interest (and PMI savings, if applicable) to exceed your closing costs.

Since the months to breakeven is always greater than zero (since there are always closing costs with a loan), it is useful to know the breakeven point. Reason: you may not stay in your current home forever. If you choose to vacate your home before the breakeven point comes, then the refinance will actually have not been worth it. Obviously, the shorter the breakeven point, the better.

Here is a simple formula for calculating it:

total closing costs divided by monthly interest savings (with new loan as compared to current loan)

The result is the number of months it will require to "break even" with your loan.

* total closing costs are anything that costs you money to complete the refinance loan, including, for example: an application fee, a loan origination fee, loan discount points, lender points, appraisal fee, inspection fee, attorney review fee, homeowner's review fee, FHA fees, a survey fee, title search and title insurance fee. Points can range from 0% to 3% of loan principal.