To Refi or Not to Refi – Is that really the question?

With mortgage rates at or near all time lows, that question is being asked thousands of times each day. But a better question might be: Does it make financial sense to refinance right now?

There are always a host of non financial reasons to refinance (replace a negative amortization loan, move from an ARM to a fixed rate, etc.) but for our purposes here in this post, we’ll look at the hard numbers.

Your Break Even Point

When deciding whether or not to refinance your current mortgage, you must factor in your closing cost recapture time – or simply put your break-even point.

When will I pass through the pain and suffering of closing cost blah, and begin to enjoy the fruits of my new loan (i.e. the monthly savings)?

It’s quite simple really…you just need to take your current principal and interest (P & I) payment, and compare that with your new (lower) payment. Take that difference and divide that number into the dollar amount it will take to close your loan (closing costs). This new number will be the number of months it will take for you to pay off the costs of the new loan.

Example:

My current loan is a 30 year fixed with a balance of $300,000 and a rate of 6.00%

This gives me a P & I payment of $ 1,790.

To keep it simple, my new loan will remain a 30 year with a balance of $300,000 and a new rate of 4.5%

My new P & I payment would be $ 1,514 – or a monthly savings of $276

If it will cost me $ 6,000 in closing costs to refinance, then my break-even point will be 21.7 months. (6,000/276 = 21.7)

The next question is – how long do I plan to stay in my home (or keep this loan)? If the answer is longer than 21.7 months , then I will exceed my break-even point and recapture my closing costs (and then some…)

You can indulge your inner financial nerd, and calculate your break-even point a few different ways (i.e. before and after taxes, with or without PMI, etc…) For more fun with financial calculators click here (requires Java).

Happy Calculating!

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