SHOULD
YOU REFINANCE?
Does
the Benefit Justify the Cost?
There
are five criticial factors in your decision. Your goal for
refinancing determines which are the most important.
- 1)
Change in monthly payments
- 2)
Change in Annual Percentage Rate (APR)
- 3)
Months to Break Even
- 4)
Change in Interest Rate Risk
- 5)
Change in Repayment Period
1)
Change in monthly payments
This is the easiest to understand and see immediate results.
What size of check do you write each month? Does it get bigger
or smaller?
Remember,
a lower monthly payment doesn't necessarily mean you are saving
money in the long run. For example, if you only have 10 years
left on your mortgage, you can reduce your monthly payments
by refinancing to a 30 year loan. Your payments will drop
considerably, but you will have also added 20 years to repay
your loan.
2)
New Annual Percentage Rate (APR)
If you want to lower your overall borrowing costs, you
should focus on the APR (Annual Percentage Rate)
The
ARP helps you compare loans since it accounts for both points
at closing and interest rate on your loan payments. So, the
APR represents the combined costs of your loan in one number.
3)
Months to Break Even
You should also look at how long it takes to recover your
refinance costs.
Compare
months to break even with how long you think you'll own your
current home. If you think you'll only be there for another
3 years, and it will take 50 months to break even, it probably
doesn't make sense to refinance.
How
Long will it take to recover your costs to refinance?
4)
Change in Interest Rate Risk
Interest Rate risk is quite simple; is there a chance that
your mortgage payments will increase? And, if so, by how much?
For
some people, a fixed rate mortgage, with its low risk is the
best choice. For others, the low initial cost of an adjustable
rate mortage (ARM) is worth the risk of increasing payments.
Do
you prefer lower initial cost with higher risk? (ARM)
Or, lower risk and higher initial cost? (Get a fixed rate
mortgage)
5)
Change in Repayment Period
Unless you refinance to a 15 year mortgage, you will likely
extend the repayment period of your mortgage.
For
example, if you bought your home 7 years ago with a 30 year
mortgage, you have 23 years remaining on your loan, If you
refinance with a new 30 year mortgage, you will have 30 years
remaining after refinancing to a new loan. This is especially
important if, after extending, you will retire before paying
off the loan.
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