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Doing the Refinance Math

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Wondering whether or not to refinance an existing mortgage typically means running some numbers. You can do this on your own but it’s probably better to talk to a loan officer and get some assistance. It really all boils down to how much you’ll save each month compared to what you’re paying now. But there are other considerations.

First, pay less attention to the change in rate. Old school myths say that it’s a good idea to refinance if current market rates are 1% or 2% lower than what you currently have. But the rate is only a part of it. The other component is the amount being financed. For larger loan amounts, maybe a reduction of only 0.5% makes sense.

For smaller loan amounts, 2% may not be enough. Instead, calculate the monthly savings and then divide that amount into the closing costs associated with the mortgage. The result is how many months it will take to ‘recover’ the closing costs in the form of monthly savings. Pay less attention to the actual rate but instead how long it will take to get your closing costs back.

Take a loan amount of $300,000 and amortize it over 30 years with a rate of 4.50%. The principal and interest payment works out to $1,520. If current market rates are at 3.5%, the new payment would be $1,347 for a savings of $173. If closing costs were $3,000, then it would take just over 17 months to recover the associated fees. Not bad. If the loan amount were $100,000 under the same scenario, the monthly savings would be $57 and recovered in 52 months, or more than four years. Probably not a good idea in this situation.

For some, the rate has less to do with the possibility of refinancing when the loan is due for a balloon payment or a hybrid loan where the initial rate is fixed for a predetermined period of time before changing into a mortgage that can adjust every six to twelve months. Refinancing out of this type of loan can be a good idea if the property is to be held for an extended period of time, especially in light of today’s low mortgage rates.

Another important thing to keep in mind is the term of the new loan. If someone has a 30 year fixed rate loan and has been paying on it for say five years, refinancing into another 30 year loan essentially wipes out the first five years of payments and starting all over again. Today however, most lenders will adjust your new loan term to match how many years are left on the mortgage. In this example, a 25 year loan could be taken out.

Finally, if it makes sense to refinance don’t wait to do so. Interest rates can change on a dime, especially if they’re headed upward. Don’t try and squeeze out another 0.125%. The downside of waiting just a bit longer could mean those lower rates are in the rear view mirror and you missed your opportunity. Besides, if rates do go down in a year or two, you can always refinance again.

Written by David Reed for Copyright © 2020 Realty Times All Rights Reserved. Reed is from Austin, Texas and is the author of The Real Estate Investor’s Guide to Financing, Your Guide to VA Loans and Decoding the New Mortgage Market. A Senior Loan Officer and Mortgage Executive for more than 20 years, he has also appeared on CNN, CNBC, Fox Business, Fox and Friends and the Today In New York show.


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