Rule of Thumb for Refinancing
I have seen lots of tips on when it makes sense to refinance your mortgage, but I disagree with some. Here is my rule of thumb on whether it makes sense to refinance - the key for me is an apples to apples comparison:
1) Establish the loan amount to compare - to keep it simple start with your current loan balance - in my case the current loan balance is $236,100.
2) Establish a monthly payment at your current mortgage interest rate. Its key to remember this is DIFFERENT than your current mortgage payment. For instance my current mortgage payment is $1278.57, but if I were to finance my current balance of $231,600 @ my current mortgage interest rate of 4.87% I would find the mortgage payment to be $1,249.46.
3) Establish a monthly payment if you refinanced at the new rate. I was looking at getting a 4.375% 30 yr loan so if I financed our existing balance of $231,600 the new monthly payment would be $1,178.81.
4) Estimate your closing costs (ignoring pre-paid items like pre-paid interest and escrow funding for property taxes and insurance). In my case I estimate that my net closing costs will be $616.95 after some credits provided by the lender.
5) Estimate a after-tax monthly savings - Calculate the difference of the monthly payments $1,249.46 - $1,178.81 = $70.65/mo. That amount is before any tax benefit. I assume that the difference would otherwise be fully deductible, and $70.65 / 33% = $47.33/mo net benefit.
6) Calculate the number of months it would take to save back your closing costs. For me that would be the net closing costs ($616.95) divided by our monthly net savings ($47.33) = ~ 13months to save back our closing costs. Keep in mind in this example our actual monthly payment change is $1278.57 - $1,178.81 = $99.76/mo.
Hopefully you can see why I pulled the trigger - if it only takes us 13 months to pay back our closing costs then we will begin to see a net benefit there after.
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