You may have heard that mortgage rates are again at 50yr lows. This is true but the bigger question you may be asking yourself is “How do I decide if refinancing my home mortgage is the right step to take?”

I am sure you have heard rule of thumb; if you reduce your mortgage 1% you should do it. That rule of thumb may be true in most cases but it is not a very sharp tool when making such a complicated financial decision. In this article I will introduce you to two concepts that will help you make the decision; Break-even period and Elimination of future interest.

When trying to decide this question many concerns may enter your mind such as “how long is this going to take," “what if my home has fallen in value," but the two biggest questions that are typically on my client’s mind are “how much is this going to cost?” and “do I have to add years to my mortgage or increase my mortgage’s balance?”

Take Emotion Out of the Equation

The answer to the question of refinancing your mortgage can be difficult to decipher especially if you start going down the inevitable roads presented with the above questions. If you start focusing on the costs of a mortgage and the potential closing costs that ensue from a refinancing, you’ll probably become disillusioned with the inherent costs of a mortgage. But remember, you have a mortgage that already has a cost to it. So why not take advantage of cheaper money. Also, do not forget that a mortgage really is a financial tool and should be treated as such when planning your long term financial goals. The best question to start with is “how much longer do you plan on owning the property." Why? Answering this question will allow to take emotion out of the decision and instead make it a mathematical one. If you plan on staying in the home longer than your break-even period then the answer is yes; you need to refinance; you will make money doing so. If no, then you do not.

Breakeven Period

The concept of a break-even period is a simple one to understand but can be a bit involved when trying to calculate. The break-even period on a refinance is the point at which the savings equal the costs of the refinance. Simply put, the break-even period equals Closing Costs divided by Monthly savings = Break-even period (months)

Let’s take an example. Say you have a $150k mortgage and your monthly payment is $899/mo. The costs to refinance are $2,800. Let’s assume you refinance the mortgage at 4% for 30 years and your new payment is $716/mo. The break-even period in this example would equal:

Closing costs / Monthly savings = Break even

$2,800 / $183 = 15 months

If you answered the prior question and came to conclusion that you plan on owning the home an additional 3 to 5 years the break-even analysis above shows that after 15months you recuperate your costs and if you own the home for only 3 more years you actually make over $3,800 in profits! Imagine that, you make money by refinancing! To get an accurate picture of your closing costs call HomeStart Capital and speak to an expert licensed mortgage originator.

I have already refinanced once, does it make sense to refinance again?

When deciding to refinance again each decision is mutually exclusive of each other. So therefore it does not matter how many times you have refinanced your mortgage. You need only worry yourself with the following question “Do I plan on owning the home longer than the break-even period?” If yes, then yes, it makes sense to refinance again.

What if I reduce my interest rate but I am unable to reduce my monthly payment. Is it a bad idea to refinance?

You may be asking yourself what if I only have 20 years left on my mortgage and I do not want to extend the life of my mortgage by getting a new 30 year mortgage. I’d rather get a 15 year mortgage but then my payment may not fall so there is no break-even period. Now what? Here’s where the concept of “Elimination of Future Interest” (de-levering) comes into play.

Let’s take the prior example: You originally had a $150k mortgage at 6% and the payment is $899/mo. However you only have 20 years left to pay with a current balance of 125,500. Say you refinance the mortgage on a 15yr mortgage at 3.5% and results in a new payment of $897/mo. Again the cost to refinance is $2,800. Using the break-even analysis would result in a pay-back period of 1,400 months ($2,800 / $2) which is nonsensical. The better way to analyze this decision would be on the basis of elimination of future interest. To calculate the elimination of future interest simply subtract the length of the new mortgage from the remaining life of your current mortgage. In this case, 20 years less 15 years. In this case you would be eliminating 5 years worth of future payments equaling $53,940!

Remaining years – New years X Current payment = Elimination of future interest

(20yrs – 15yrs) X $899/mo x 12months = $53,940

Need help calculating the numbers or need some direction with the above decision? Call Eduardo Adame or one of our expert licensed mortgage originators today at (713) 275-2785 or visit us at www.homestartcapital.com.