From Retirement Insider Editor Bob Irish in the Wealth Builders Club: The Fed’s zero-interest-rate policy has resulted in the lowest mortgage rates in more than 30 years…
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Low mortgage rates make refinancing appealing. But a “refi” may not save you money—it could end up costing you more.
To decide if refinancing is a good option for you, you must do the math.
The first number you need to know is your break-even point. That is, how many years it’ll take for the refi to pay for itself.
Let’s say the refi will lower your mortgage payment by $125 per month, and your closing costs are $4,500.
It’ll take three years (36 months x $125 = $4,500) for you to save enough with the refi to cover your costs. So, unless you plan to be in your home for at least three more years, stick with your current mortgage.
Here’s a free refinance calculator that’ll help you determine your break-even point.
 Don’t fall for mortgages with “no closing costs.” There’s no such thing. Some lenders will roll your closing costs into your loan balance, so you’ll wind up borrowing more money and paying interest on your supposed savings.
Others will charge you an above-market interest rate that compensates them for covering your closing costs. As a result, you’re saddled with a higher mortgage payment for the life of the loan. |
But the break-even point isn’t the only number you need…
You have to know what your total savings will be over the life of the loan. The easiest way to figure it out is with a loan amortization calculator.
Let’s look at an example:
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Ten years ago, Lisa borrowed $200,000 to buy her home. She got a 30-year mortgage at a rate of 6%. Her monthly payment is $1,200.
She has 20 years left on the loan. It’d cost her $288,000 to pay it off (240 months x $1,200 = $288,000). She’s thinking of refinancing her current mortgage balance of $167,000 at 4.5%. If she opts for a 30-year term with the new mortgage, her monthly payment will be $846. If she opts for a 15-year term, her monthly payment will be $1,278. With a monthly payment of $846, it seems like the 30-year mortgage makes sense, right? Let’s do the math… The 30-year mortgage will cost her $304,560 over the life of the loan (360 months x $846 = $304,560). That’s $15,672 more than the $288,000 she’ll pay on her current mortgage. But the 15-year mortgage will cost her $230,040 (180 months x $1,278 = $230,040). That’ll save her $57,960 over the life of the loan ($288,000 – $230,040 = $57,960). |
So, from a long-term perspective, her current mortgage and the 15-year refi are better than the 30-year refi. But Lisa will only realize the savings if she stays in her house for the life of the loan (Americans stay in their homes an average of seven years).
In the short term, the 30-year refi will save Lisa $354 per month compared to her current mortgage.
Bottom line: Before you refinance, you need to look at your break-even point, your cash-flow needs, and the length of time you expect to stay in your house.
You can read all my mortgage “do’s and don’ts” inside the Wealth Builders Club. Look for Wealth Stealers Essay No. 13: “Homeowners Beware: Protect Yourself From These Common Mortgage Scams.”