Financial Planning, Millennials

Should I Refinance My Mortgage?

Aside from bragging about investing right at the dip in March, refinancing your mortgage is one of the hottest topics in the personal finance world. Interest rates have dropped drastically over the past couple of years, so it only makes sense to talk about refinancing when it can benefit so many people.

So what does it mean to refinance your mortgage?

Refinancing your mortgage is when you pay off your existing loan and replace it with a new one. Oftentimes people choose to refinance to take advantage of lower interest rates, to change the terms in years of the mortgage, or to tap into their home equity. Since interest rates are what are leading most people to refinance right now, that is what we are going to focus on in this blog post.

To determine whether you should refinance is not as simple as comparing the previous monthly payment to what the new one monthly payment would be if you refinance. You need to understand all the costs associated with refinancing and whether or not it will lead to savings for you. 

The factors you need to know are: the amount of time you will live in the house, the closing costs to refinance, the new interest rate, and what the new monthly payment will be. Once you know all of these factors, then you can determine what is the most beneficial for you.

To make the best decision follow this equation.

Closing costs / monthly savings = Breakeven time

If breakeven time > time planned to live there…Then you ❌ refinance.

If breakeven time < time planned to live there…Then you refinance.

Here’s a couple examples 👇 to help illustrate whether you should refinance or not.

Kayla and Adam have the current situation: 

Current Interest Rate:4.5%
Current Monthly Payment:$1,400
New Interest Rate:3.25%
New Monthly Payment:$1,220
Closing Costs:$2,500 
Monthly Savings:$180
Time planned to live there:> 120 months 
Note: If you don’t want to do the math by hand, here is a website that can calculate it for you.

If Kayla and Adam were to refinance their home, they would save $180/month in savings. However, to determine if it is in their best interest to refinance you need to factor in the closing costs. With $2,500 of closing costs, they would need to live in the house for at least 14 months for it to make sense ($2,500 / $180 per month = 13.89 months).

13.89 months < 120 months

Since Kayla and Adam plan to stay in their current home for 10 more years, they should refinance. It would result in savings of $180 every month after the breakeven point.  I don’t know about you, but I would love to have an additional $180 in my monthly budget.

Let’s look at another example to help reinforce the idea. 

Alex and Tara have the following situation: 

Current Interest Rate:4%
Current Monthly Payment:$1,100
New Interest Rate:3.35%
New Monthly Payment:$1,025
Closing Costs:$3,000 
Monthly Savings:$75
Time planned to live there:36 months
Note: If you don’t want to do the math by hand, here is a website that can calculate it for you.

Following the same principle in the previous example, if Alex and Tara were to refinance they would save $75 a month, but you have to factor in the closing costs again. Based on a $3,000 closing cost, it would take 40 months to hit a breakeven point ($3,000 / $75 per month = 40 months). 

40 months > 36 months

Since Alex and Tara only plan to live there for 36 months, then they should not refinance. If they did, they would end up losing money in the long run which is definitely not the goal. 

As you can see, the key to understanding whether you should refinance or not, is to find the breakeven point in months and then figure out if you plan to live in your house beyond that. Because there are some grey areas where rules of thumb don’t apply, consult your financial advisor or loan officer to determine the best option for you.

I know it can be hard to predict the future and know the amount of time you will live in your house, but just make the best guess you can. That’s all you can do. Once you know that, then you can determine whether you should refinance or not.

Hopefully this helps you understand the factors needed to evaluate whether it makes sense for you and your family to refinance! It is safe to say that it is something worth evaluating as it potentially could save you some money in the long run. 

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