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Of course, each borrower's position is different, but we can give you some rules of thumb to help you decide whether to pursue refinancing. You should make a final determination, however, only after consulting a mortgage professional and, if necessary, a tax professional.

Generally speaking, a borrower can pursue one of two main objectives through refinancing: (a) reduction in monthly payments by refinancing at a lower interest rate, or (b) reduction in total interest costs over the life of a shorter loan. If the object is to lower monthly payments by refinancing to a mortgage product with a similar term, the borrower's first step is to do a break-even analysis by dividing the monthly interest savings into the cost of the refinancing. The costs should not include costs that the borrower would pay in any event, such as taxes and insurance, but does include points, origination fees and cost associated with the application and closing. Your mortgage loan representative can help you with a Good Faith Estimate of those costs. The break-even analysis tells the borrow the point in time at which she has amortized the refinancing costs and starts to enjoy savings through the lower interest rate (see example "A," below). If the borrower plans to stay in the property for a reasonable period after the break-even point, refinancing makes sense and her objective will be accomplished.

The alternative goal for a refinance may be to significantly reduce the total amount of interest paid out over the life of the loan. Generally, this is accomplished by refinancing to a shorter term product at an interest rate equal to or lower than the rate of the borrower's current loan (see example "B," below. There are several possible motivations for taking this approach. First, by lowering the total cost of the loan, the borrower's equity in the property will generally be greater faster. Second, the total actual cost of the property will be significantly lower. Second, the pay-off will be lower faster, allowing more flexibility in marketing the property when (if) the borrower decides to sell. Finally, in some cases there may be a tax advantage to recognizing more interest paid per year in a shorter term product. A tax professional should always be consulted on this point..

 

Here is an example of each of the two approaches
described :

Example A:

Assume that the cost of refinancing your current mortgage is $3,000 in points, origination fee, appraisal and closing costs. Remember, disregard the "pre-paids," such as taxes and home owner's insurance, because refinancing will not effect these items since you will pay them to one lender or another. If the monthly payment on the refinanced loan is $100 lower than your current mortgage payment, you will break even in thirty months (one and a half years). After that point, you have repaid yourself the cost of the refinancing and start to enjoy your savings, so you save $100 per month from that point on.

Example B:

If your objective is to reduce the total real cost of your home, or pay off the loan sooner, or build your equity faster, or all three, consider switching to a shorter term loan program at a rate equal to or lower than your current rate. For example, if you refinance a $100,000 payoff from a thirty year fixed rate mortgage at 7.5% to a fifteen year fixed rate at 6%, your payments will go up from about (without including taxes and insurance) $695 per month to about $840 per month. However, the total cost of your house changes from $250,200 on a thirty-year loan to $151,200, or a savings $91,000. In addition, as the value of your house increases over the next 15 years, your loan balance is reducing at a much higher rate than when you were in a thirty-year program, so the increase in your equity has accelerated. In effect, you are putting that $91,000 into a kind of savings or real estate investment.

This article is designed to give you the general idea of how to approach the question of refinancing. Call us today, and one of our mortgage professionals can help you with precise calculations.