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The Right Time To Refinance

You’ve been watching mortgage interest rates drop now for the last several months. You’ve heard a couple of experts say that they believe it has bottomed out and will start rising some time soon. You toss the idea around in your head and ask several friends what they think. Still, you’re not sure. Should you refinance your mortgage?

Your home mortgage is one of the largest expenses in your household budget. Moreover, it’s a fixed cost that will run through most of your adult life. Even a small reduction over time could add up to significant savings.

To make that decision, you will need to compare the cost of obtaining a new mortgage against the savings you will enjoy with a reduced interest rate. At the same time, you may also want to consider switching to a different type of mortgage, such as from a 5-year balloon to a 15-year fixed-rate mortgage.

Here is an example and a worksheet that will help you determine if refinancing makes sense for you. Rick and Carol have a home they bought three years ago for $300,000. They have five years remaining on a balloon mortgage of $200,000 with an interest rate of 7.25%. Their monthly payments are $1,364.35. They intend to live in their home for several years and would like to lock in a 30-year mortgage with a 6.25% fixed rate.

Rick and Carol's Example

New Mortgage Costs Calculating the Savings
Discount points (in $) $ - Monthly payment on current mortgage $1364.35
Origination points (if any) $ - Monthly payment on new mortgage $1241.43
Application fee $ 125 Difference between two mortgage payments $132.92
Credit check fee $ 50 Divide total fees on new mortgage by monthly savings - This is the number of months to recover your costs. 10 months
Attorney fees (yours) $ 400    
Attorney fees (lender's) $ -    
Title search fee $ -    
Title insurance fee $ 300    
Appraisal fee $ 300    
Inspections $ -    
Local fees (taxes, transfers) $ -    
Other fees $ 75    
Total cost of new mortgage $ 1250    

In this example, it would cost Rick and Carol $1,250 to refinance their new mortgage. With their reduced monthly payments, it would take 10 months to recoup those costs. The recovery period is important because Rick and Carol would need to stay in their home for at least that long for the refinancing to make sense.

After the recovery period, they would lower their annual mortgage payments by $1,600 and lock in the lower rate for 30 years, regardless of what happens to interest rates. If they decided not to move, they would save about $48,000 in total interest over the course of the mortgage. More importantly, they would have eliminated the approaching balloon payment from their old mortgage.

Here is a worksheet you can use to determine whether refinancing makes sense in your particular situation. You may choose to use a refinance calculator here.

Worksheets for your use

New Mortgage Costs Calculating the Savings
Discount points (in $) $ Monthly payment on current mortgage $
Origination points (if any) $ Monthly payment on new mortgage $
Application fee $ Difference between two mortgage payments $
Credit check fee $ Divide total fees on new mortgage by monthly savings - This is the number of months to recover your costs.  
Attorney fees (yours) $    
Attorney fees (lender's) $    
Title search fee $    
Title insurance fee $    
Appraisal fee $    
Inspections $    
Local fees (taxes, transfers) $    
Other fees $    
Total cost of new mortgage $    

In addition, you might want to access mortgage refinancing calculators on many websites that can help you determine the monthly payments for any size mortgage with any interest rate.

Other considerations
When considering refinancing, you might also look at refinancing a larger or smaller amount than the current balance on your mortgage. If you have excess funds and believe that you won’t get a return greater than your current mortgage rate, you may want to pay down your mortgage and secure a smaller mortgage.

If you need cash for other needs, you may want to refinance a larger amount. Remember that mortgage interest is tax deductible (if you itemize your deductions on your tax return). Consult your tax advisor to see how this may apply to your situation.

Final thoughts
No interest rate environment lasts forever. Unfortunately, there is no crystal ball that will tell you whether rates will continue to drop or go back up. But by evaluating your mortgage situation now, you will be prepared to move if and when refinancing makes sense for you.