How to decide if it’s time to Refinance?

by Tom Reddin on May 11, 2012

When to refinance your mortgage?

One of the toughest decisions for a homeowner is to determine whether it’s time to refinance their mortgage.   There are a series of variables to consider, and here are a few tips for helping to figure out whether that time is right for you.

The first question you have to ask yourself is “How long am I going to be in my home?”.   For the typical homeowner in America, the time they stay in their home is, on average, approximately 7 years.   Of course, this will vary widely depending on your personal situation.   This is a critical factor in deciding whether now is the right time to refinance your mortgage because there will be fixed costs to refinance such as loan origination fees, attorney’s fees, title search/insurance fees, documentation fees, discount points etc.   There are other smaller fees such as flood certification fees, etc., but they are smaller than the five big ones listed above.

These fees can easily add up to $1,500 to $2,000 on the low end.   And if you are buying discount points to reduce your interest rate, they can be much higher.  So let’s say you are on the lower end of these payments, and have no loan origination fee or discount points, but you spend $400 for an attorney fee, $600 for  title search and insurance, $350 for the lender’s documentation fees and $150 in all the other misc. costs.    That sums to $1,500 in one time fixed costs for the refinance transaction.

You need to then figure out your annual savings on interest expense.   Let’s say you have a $250,000 mortgage and you are going to reduce your annual interest rate by 0.50%.    This would generate approximately $1,250 in annual interest savings (before compounding effect), which means you would pay back your $1,500 in fixed costs in just over 14 months.    This is a no-brainer to go ahead and refinance, unless you think you are going to be moving out of the house within a year.

Now let’s look at a different scenario.  Let’s say you have a $200,000 mortgage, and will only be reducing your interest rate by 0.25%.   This would generate approximately $500 in annual interest savings (before the compounding effect).    And let’s assume that you paid a 1% loan origination fee which would be $2,000 plus the same $1,500 in fixed costs for the attorney’s fee, title search/insurance, documentation fee and misc expenses.  That’s a total of $3,500 in upfront fixed costs.   Now it will take 7 years to pay back the upfront expenses ($3,500) with the annual interest rate savings ($500).   Are you sure you are going to be in the home for 7 more years?   And is it worth the hassle of the all paper and documentation work, time commitment and the risk of spending the upfront costs?   This is a tougher one to call.

So, hopefully you can see from these two examples, that you really have to get your calculator out to figure whether it makes sense to refinance for your particular situation.

We have recently experienced new record low mortgage rates, so it’s not a bad time to spend a an hour or so to consider this.

Just make sure you ask yourself that question about how long you’ll be in your home first, because it will end up influencing your decision considerably.

Hope this is helpful.

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