When to Refinance Your Mortgage

Don’t pay attention to “Rules of Thumb” when deciding to refinance your mortgage. Instead, run a simple calculation to determine what is best for you. In most cases, you will save money by refinancing to a lower rate, but how long it takes to realize these savings can vary.

As an example let’s assume you have a typical $200,000 mortgage with a 30 year fixed rate of 6.5% interest. You ask your bank about refinancing to a lower interest rate and they present the following:

The bank is currently offering a 30 year fixed rate of 5.625% for 30 years with total points and other closing fees totaling $2220*.

In other words if you pay the bank $2220 and sign a bunch of paperwork your interest rate will be changed from 6.5% to 5.625%. Is this a good deal?

Let’s break the deal down:

If you do nothing you keep paying your loan as originally agreed your total interest paid for the year is 6.5% X $200000 = $13000.

If you refinance and pay the $2220 closing fee the total interest paid for the year is 5.625% X $200000 = $11250.

By refinancing you can save approximately $1750 a year** ($13000-$11250) but remember you paid $2220 for this privilege.

From hear you can calculate how long it will take to reach your break even point.

Let x = Closing Cost Fees

Let y = Interest savings per year.

Break Even Point = x ÷ y or $2220 ÷$1750 = 1.3 Years

In this example it will only take 1.3 years to break even on your refinance. Every year after that you will be saving money. Providing you have the funds to cover closing costs, and don’t plan on moving within your breakeven point, refinancing will always save you money in interest.