Historically, common wisdom said that you should refinance if you can reduce your mortgage interest rate by 2%. However, many people refinance if they can lower their interest rate by 1%. You should definitely refinance an adjustable rate mortgage to a fixed rate thirty-year or fifteen-year mortgage to protect yourself against interest rate increases. Essentially, the decision to refinance should be based on a cost/benefit analysis. What will it cost you to refinance, and how much will you save per month? Calculate how many months it will take you to get back the fees you paid to refinance from the savings. Bankrate.com has a refinancing calculator to show you how much you can save and how long it will take you to get your fees back. The fees to refinance are similar to the fees to take out the original mortgage:
- Origination fee
- Appraisal fee
- Application fee
- Attorney fee (deed preparation)
- Inspection fee (termites or radon)
- Title insurance
- Other fees (PMI insurance)
These could total up to 2% of the new financed amount. Always ask the bank early on what the fees for refinancing add up to. This will enable you to do an informed cost/benefit analysis.
- Table 11.2. Refinancing Example
- Your current monthly mortgage payment ($1,199)
- Subtract your new monthly payment (minus $1,073)
- This equals your monthly savings ($126)
- Subtract your tax rate from 1 (e.g. 1 minus 0.28 equals 0.72)
- Multiply your monthly savings (#3) by your after-tax rate (#4) (126 times 0.72)
- This equals your after-tax savings ($91)
- Total of your new loans’ fees and closing costs ($2,500)
- Divide total costs by your monthly after-tax savings (from #6) ($2,500 divided by $91)
- This is the number of months it will take you to recover your financing costs (27 months)