Refinancing 101: Should I Refinance?

A mortgage refinance can change your life in a lot of positive ways. It could help you lower your mortgage payment, consolidate debt, save money on interest by paying off your loan sooner or lock in a low fixed interest rate to make sure your payment never goes up.

But, while refinancing offers a range of benefits, there are costs involved, either paid up front or built into the new mortgage. How to decide if a refinance will end up saving you money? There's no one-size-fits-all answer, but we've got a few tips for figuring out whether the numbers add up for your situation.

Calculating Your Break-Even Point

If your main goal is to save money, one way to decide if you should refinance your mortgage is to calculate how long it will take you to reach your break-even point, meaning the point at which the amount of your refinance savings equals the amount it cost you to refinance.

This break-even point could take anywhere from months to years to reach, but, depending on your financial goals, it could still make refinancing a good idea. For example, if you know you want to live in your house for longer than your break-even point, you'll be able to look forward to a time when your savings start stacking up.

To calculate your break-even point, you'll need to answer three questions:

• How much is my current payment? Your current payment is the principal and interest (P&I) portion of the amount you pay every month for your mortgage. For this calculation, don't include property tax, homeowner insurance or other fees.
• How much will my new payment be? Your new payment is the P&I portion of the amount you'll pay every month after you refinance. Again, this amount shouldn't include taxes or other mortgage-related fees that you pay monthly. Once you decide the total mortgage loan amount you'd like to apply for, a mortgage calculator can give you a quick estimate of your new payment.
• How much will it cost to refinance my mortgage? If you're shopping for a refinance, lenders will provide you with a loan estimate that explains the various costs associated with refinancing, including loan origination, loan points, appraisal, title search and insurance. A good rule of thumb is to budget 3 to 5 percent of the refinanced amount for closing costs, but remember: The total amount will depend on your loan amount and the type of loan you choose, among other factors.

Once you have these numbers (even just an estimate is a good starting point), simply divide the cost of refinancing by the difference between your old monthly payment and your new monthly payment. Here's a quick example:

Let's say 10 years ago you took out a $500,000 loan, with a 30-year term and an original interest rate of 5 percent. If you refinanced that mortgage into a new 30-year term, with a new rate of 3 percent, here's what your calculation might look like:

Current payment: $2,684

New payment: $1,671

Monthly savings: $1,013

Estimated cost to refinance: $12,000

Break-even point: 11.8 months ($12,000 ÷ $1,013)

In this case, you'd break even in under a year, and start saving money in your second year and beyond. (Keep in mind this example is simplified for explanation purposes.)

Consider Your Plans for the Near Future

One of the main reasons to calculate your break even point is that it's possible that a refinance won't actually save you money if you don't own the house long enough. For example, many people sell their home before they pay off their mortgage. If you're planning to sell soon, especially before you reach your break even point, refinancing may not make sense, because you won't have as much time to recoup your costs and maximize your savings before you move. After all, refinancing doesn't adjust the value in your home, just the cost of financing it.

One Situation in Which Break Even Doesn't Matter

There is one kind of rate-and-term refinance in which you don't have to worry about finding your break even point. If your main goal is to pay off your mortgage sooner, to reduce the total amount of interest you pay on it, it's probable that you'll refinance with a shorter term. This will likely increase your monthly payments for the remainder of the mortgage, and you'll need to pay closing costs, meaning you won't save money in the short term, but once you completely pay off the loan, you'll have paid less interest overall. If you're in a position to pay more per month on your mortgage payments, this can be a really smart move over the long haul.

Should I refinance now?

If you're ready to refinance or just curious about your options, you should go ahead and reach out to a loan officer at your local bank. A loan officer can help you calculate your break-even point and guide you through the process of refinancing. The sooner you call, the sooner you can start getting all the benefits of your new mortgage.

And if you need more information on how to find a great lender, check out our blog post "How to Choose a Lender for your Mortgage Refinance" for the most important questions you should ask potential lenders.