Refinancing Your Mortgage: Calculating Potential Benefits

With rates close to record lows, home owners may have a great opportunity to save by refinancing to lower mortgage rates. Before committing to a particular lender you should estimate your possible savings, and the terms of potential refinancing terms.

How Long Before You Realize Savings?

In order to calculate the overall savings you may realize by refinancing, you should calculate the breakeven amount and breakeven period.

Step 1: Calculate Your Breakeven Dollar Amount

Finding the breakeven amount on refinancing costs is essential to saving money on your mortgage. When you refinance to a lower mortgage rate, your refinanced mortgage should completely offset your total refinance costs.

Refinancing your mortgage incurs many fees, which may include:

• Cash Contribution: Although a down payment may not be needed to refinance your mortgage, you may be asked to contribute cash to meet maximum loan to value (LTV) requirements should your home's appraisal price fall short of the estimated value. You might also include any lost interest if your cash contribution was withdrawn from an interest bearing account
• Closing Costs: These include, but may not be limited to lender fees, closing agent fees, title insurance, disbursements to lenders, hazard and mortgage insurance companies, property tax collectors, and appraisals
• Points: This is a payment for securing a favorable interest rate. One point is equal to 1% of your refinance mortgage loan amount. Paying one point on a $250,000 home loan is equal to $2500

Calculate the total estimated cost of your refinance and write it down. You will use this figure later to calculate how long it may take before realizing refinance savings.

Step 2: Determine Your Breakeven Period

A free online mortgage calculator can compare mortgage loan terms, and estimate monthly payment amounts. You can also use an online mortgage calculator to determine your breakeven period by taking the following steps:

1. Use a mortgage payment calculator to estimating your principal and interest (P&I) payment for your refinanced mortgage
2. Subtract the potential refinanced P&I amount from your current P&I payment

If your current P&I payment is $1250, and the estimated P&I payment for your refinanced mortgage is $1020, your estimated savings would be $230 per month. Lowering your mortgage rate may result in larger savings, but actual results are based on refinance costs and other factors.

Step 3: Subtract the Breakeven Amount from the Monthly Savings Amount

Finding your breakeven point establishes when you should start realizing savings on your new home loan.

To calculate the breakeven period, divide the total refinancing costs by the amount of monthly savings. For instance, if your refinancing costs (from step 1) are $6,300, you divide $6,300 by $230. The result is 27.4 months. You can check your work by multiplying your estimated monthly savings by the number of months it takes to break even.

In this particular example, your breakeven period is about 28 months, or 2 years and 4 months. If you are planning to move within 2 years, you would not save with these refinancing terms.

How to Calculate Your Total Refinance Savings

Once you've estimated the cost of refinancing your mortgage loan and your breakeven period, you can calculate your potential overall savings.

Savings Example

Using the figures from the example above, you can calculate the overall savings from refinancing your mortgage

1. Figure out how many payments, beyond the 28 month breakeven period, you have left before your mortgage is paid-off (or when you predict you may sell your home). To simplify the equation, let's say you plan to sell your home 10 years (120 payments) after the breakeven period
2. Take the monthly savings amount of $230 and multiply it by 120 payments ($230 x 120)

Based on this example, if you keep your home and refinanced mortgage for ten years after the breakeven period, your estimated savings would be about $27,600.

Your savings can also be impacted by your income tax bracket and individual circumstances. Please contact a financial advisor or tax accountant to determine your actual savings for your particular circumstances.