Most people refinance to get a lower mortgage payment; however, many neglect to consider how much refinancing is going to cost them. If you overpay at closing by paying too much for the loan origination fee or unnecessary discount points you could be losing money no matter how low refinance rates drop. Here are several tips to help you answer the question should I refinance my mortgage now.
Getting The Lowest Refinance Rates At All Costs
One of the most common mortgage refinancing mistakes is focusing on getting the lowest refinance rates at the expense of fees. If you’re not able to break even recouping your closing costs from the lower payment amount you’re going to be losing money no matter how low your interest rate. Doing the math when shopping for a mortgage rate is the best way to make sure you’re not wasting time and money refinancing.
Here’s how to factor in time and fees to see if you should refinance your mortgage. How much you’ll save at the end of the day depends on how long you plan on keeping the loan and how much you’ll pay at closing. Keep in mind that the average homeowner refinances every 4-5 years so you need to recoup your expenses before taking out a new loan.
First, add up all of your mortgage fees including any discount points, mortgage loan origination, the appraisal, title insurance, underwriting, attorney fees, and administrative fees. You can use the Good Faith Estimate for this, paying close attention to section 800, which is where you’ll find fees you can negotiate as well as lender junk fees.
Refinancing Affects Your Mortgage Interest Deduction
Second, calculate how much you’ll be saving with the new refinance rates by subtracting the new, lower mortgage payment from how much you’re paying now. You can factor in your tax expenses by multiplying this savings amount by your combined federal and state tax rate. Many homeowners don’t realize they’ll be taking a hit on their mortgage interest tax deduction until the following year, meaning your tax liability could go up as a result of refinancing your mortgage loan.
You can calculate your net savings from mortgage refinancing by subtracting your tax costs from your monthly savings from the previous step. Remember, cheaper mortgage loans result in smaller tax benefits for you.
Finally, calculate your break-even point by diving your total mortgage closing costs by your net savings and you’ve got the number of months it’s going to take you to pay off the cost your new home loan. It’s worth mentioning that this calculation is only valid if you choose a mortgage with the same term length as your old loan, 30-year to 30-year home loan for example.
If you go shorter, with a 15-year mortgage your break-even point will come sooner than what you’ve calculated. If you go with a longer term length you’ll basically never break even because of higher finance charges for those extra years so this calculation is no longer valid.
Here’s an example to illustrate how this break-even calculation works:
Suppose your net savings are $150 each month based on today’s lowest refinance rates. Your closing costs including the loan origination fee total $3,500. Based on these figures it will take you two years to break even before you realize any savings from mortgage refinancing. ($3,500/$150 = 24 months) If you’re planning on selling your home within two years refinancing is probably not a good idea.
Beware Hidden Mortgage Costs
If you’ve decided to go forward with mortgage refinancing you need to make sure your existing home loan does not include a prepayment penalty. If your mortgage contract does include a penalty for early payoff make sure you’re including this expense in your break-even calculation. A typical prepayment penalty will set you back as much as six months interest on 80% of your mortgage balance.
Discount points are another fee you’ll want to avoid whenever possible. Comparing loan offers when shopping for the lowest refinance rates is best done with zero point quotes, even though most lenders fill their tables with offers that include points.
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