Whether you are a homeowner or you work as a real estate professional, one of the most important questions to answer right now is “When is the time to refinance?”
Homeowners need to know how to weigh the pros and cons of refinancing, by calculating their potential savings versus the costs of refinancing, because a smart refinance can save thousands of dollars. Meanwhile real estate agents, brokers, and others in a professional position to advice and educate consumers need to have a way to explain refinance calculations to their homeowner clients and customers.
Most homeowners should only refinance if they are able to shave at least two percentage points off of their interest rate. That way it is possible to offset the required refinance expenses that include such things as application fees, points, and other miscellaneous costs while still saving money on the monthly payment.
Here’s an example:
• If you spend $1,200 to pay for refinance costs and that allows you to lower the monthly mortgage payment by $100, then it will take you 12 months to recoup the closing costs. That means that you’ll start saving money in the 13th month, and will continue to save $1,200 a year for as long as you pay on the loan.
• But spend the same amount to reduce a mortgage payment by $25 and the positive impact will not be felt for 48 months. So if you are planning to sell your house within the next 3-4 years, that strategy does not make sense. You will not even break even on your refinance costs within that period of time, so doing a “refi” will save you nothing and wind up costing you money you can’t recover.
• To make it easy to crunch the numbers you can talk to a knowledgeable mortgage broker or loan officer. Once they figure out what interest rate you qualify for on a refinance loan they can also estimate total closing costs to help you calculate the bottom line.
• If the current loan paperwork includes a prepayment penalty clause that can also trigger additional fees which could be substantial. Prepayment clauses are sometimes added by lenders, so that if you try to pay off your loan early – or refinance out of it into a less expensive loan – you get penalized. So it is always a good idea to consult a real estate attorney before signing any mortgage document, to ensure that you fully understand what it is you are agreeing to.
But when you do a refinance, don’t forget to factor in other things that could affect your net savings, such as where you will get the money to pay for your closing costs. Let’s say you need to pay $1,200 to refinance and save three percent on your mortgage interest. If you also happen to owe $1,000 on a credit card that charges 25 percent interest, it may be wiser to pay off your plastic first. So whether or not you do a refinance should also be considered within the context of your own particular financial situation.
Potential savings will always depend upon the type of loan, any available discounts being offered by lenders, and the time-frame for staying in the house before deciding to sell. Keep in mind that the ultimate goal is not just to capture a lower interest rate, per se, but to realize actual net savings.