Refinancing Your Mortgage: Calculating the Costs

Comparing refinance rates is a first step toward getting your best refinancing terms, but the cost of refinancing a mortgage loan is also a consideration. Here's how to compare interest rates, identify potential savings, and determine how long it will take to break even on closing costs and points paid for refinancing.

• Estimate how long you'll keep your mortgage: Although mortgage loans typically have repayment terms of 15 to 30 years or more, the actual life of a mortgage loan averages about seven years. (We're using seven years for sample calculations in this article.)
• Compare your monthly principle and interest (P&I) payments of your existing mortgage to your potential refinance mortgage: Use only the P&I portion of your mortgage payment; don't include amounts paid for taxes and insurance.
• Subtract the monthly interest payment for the refinance mortgage from your current interest payment: The difference represents potential monthly savings. If your current interest paid is $950, and your interest payment after refinancing is $750, your potential monthly savings is $200. If you only look at the difference between total monthly payments, you may not be seeing true savings as stretching out a current balance over a longer term could lower your payment but cost you more in interest.
  
  
• Multiply the monthly savings amount by the number of months you plan to have the new mortgage loan: Using the example above $200 x 84 months (seven years) = potential savings of $16,800 over the estimated life of your new mortgage loan.

It's easy to estimate immediate savings when comparing your current mortgage rate to lower refinance rates, but there's more involved in accurately determining savings. Calculating how long it takes to break even on paying closing costs and points is essential for deciding whether or not to refinance.

Upfront Refinance Costs: Closing And Points

Refinancing requires paying closing costs, and in many cases, points.

• Calculate points you're paying: One point is equal to one percent of your new mortgage loan amount. If you're paying two points on a $250,000 mortgage, that's $5,000 in addition to customary closing costs.
• Add the amount of closing costs and points and divide by the amount of monthly savings: This provides your break-even period, which is how many months it will take to start realizing interest savings after paying closing costs and points.
• Divide the number of months by 12 to determine how many years it will take to break even: Using monthly savings of $200, points of $5000, and closing costs of $2000, divide $7000 by $200. The result for our example is 35 months; it will take two years and eleven months to break even on closing costs and points.
• Multiply the monthly savings amount by the number of months remaining after the break even period: Net savings based on keeping your refinance mortgage for seven years would be $200 x 49 months = $9800.

There are additional considerations, such as the potential for interest earned by the money not spent on points, or savings created by paying off higher-interest debts is different with the money instead. Everyone's situation the scope of this article doesn't permit addressing all possible scenarios.

Refinancing Benefits Depend on Variables

Consulting a financial advisor or tax professional can help in determining additional benefits of refinancing your mortgage loan He or she can also perform complex computations needed when comparing your current mortgage to potential benefits of cash out refinancing

• Debt consolidation: Paying off high interest credit card debt with low mortgage rate refinancing makes sense, but savings depends on credit card rates and how long you keep your cash-out refinance loan.
• Income tax benefits: Mortgage interest and points may be deductible; see your tax advisor for details.
• Cash out refinancing for home improvement: If you're planning to remodel your home, consult a financial advisor and real estate professional to learn how home improvements can increase the value of your home. This factors in to deciding how and if refinancing for funding home improvements works according to your circumstances.

Getting Lowest Refinance Rates Only the Beginning

Estimating potential benefits of a refinance mortgage requires these steps:

• Determining monthly savings
• Estimating closing costs and points
• Establishing the break-even period for closing costs and points
• Addressing individual situations that can impact refinancing benefits

Mortgage lenders are happy to help with savings estimates and answering your questions about mortgage loans and refinancing terms. Contact lenders for clarifying mortgage quotes, discussing refinance options, and answering any questions you may have about refinance mortgages and procedures.