Does refinancing make sense for you?

There are four different reasons to refinance and depending on the reason, there are different ways to decide when it will make sense to refinance.

When refinancing, you are either looking to:

lower your monthly payments

consolidate some debt

get cash out of your home's equity

or shorten the length of your loan term

(this IS the biggest money saver!)

This article will give you some basic guidelines to use for when it makes sense to refinance, but please read the articles on each reason to get a more in depth look at how to save on a refinance.

Lower Your Monthly Payments
Most people immediately think of getting a lower interest rate when it comes to lowering monthly payments and that is certainly the simplest method of getting a lower payment.

For the borrower who keeps the home or will refinance in 5 years it is pretty easy. If it cost $1500 to refinance and you save $100 a month, you have saved the money in just 15 months. This means that the rest of the 60 months you keep the loan is pure profit. Do it.

Generally, good advice is that the savings should get your money back in about 3 years for this to make sense.

You may plan to stay longer, but things change. You may sell, you may refinance, you may add an addition and decide to refinance to take cash out. Unless you are very conservative, anything over 3 years is taking a chance.

Here is another way to look at it. The average loan closing costs are about $1500. If you need to save $1500 in 3 years, if you can save $42 a month or more you are in good shape. You should look into refinancing to save yourself some money.

Be Careful about adding years to the Mortgage
The way to figure when it makes sense depends also on whether you will keep the loan for the entire length of the loan. If you will sell the home in 5 or 10 years, you are only concerned with how many months to recapture the cost. If you keep the loan the whole 30 years, you need to look at the total cost of the mortgage payments in making a decision.

In looking at whether the this makes sense for you, you need to consider the savings per month on one side and the costs to refinance PLUS any time you are adding back to the loan to determine if this makes sense for you. Many borrowers forget to consider what they are adding back in the form of payments in deciding whether they are saving money and often could actually save more by shortening the length of the loan.

If this is the one refinance you will do, compare the payments you would have at the lower interest rate for the number of years you have remaining on the mortgage before the refinance.

For instance, if you have had a 30 year fixed rate mortgage for 2 years, you refinance to save $100 per month and the cost to refinance is $1500 and you go back to a 30 year fixed again.

Compare the payments of the new mortgage at what they would be for only 28 years for an accurate estimate. In this case, that would mean you only save about $75 per month and recapture the money in 20 months instead of 15 for a more accurate figure.

In fact, when you refinance to a longer term it is not a bad idea to pay the extra to have the loan completed in the 28 years by adding in an extra $25 with each payment. It may not sound like much, but over the life of the loan that $25 a month would have saved you $15,050 in interest in addition to the $75 a month.

Consolidating Debt
If you are consolidating debt, does it make sense to refinance is a different animal all together. You want to lower your total monthly payments by paying off debt such as credit cards or other high interest loans, but you also want to get that debt paid off.

Only consolidate debt onto your mortgage if you intend to pay extra evey month and whittle down that extra balance you added in. Saving money is a great thing, but you need to look at how long it will take to pay the balance on the mortgage back down to where it was before you refinanced in deciding if it makes sense.

Get the debt all paid off, THEN sit back and enjoy the savings.

Let's say that consolidating the debt saves you $500 per month in payments, but adds $10,000 to your mortgage. If you pay the $500 a month to the balance, it take just 20 months to have it all paid off. IF you pay even an extra $250 per month, you could pay off that $10,000 in 40 months and keep an extra $250.

Compare this to how long it would take to pay off the credit cards paying $250 per month. For instance, $10,000 at 18% interest would take 5 years to pay off at $253.93 per month. In this case, the $250 per month by adding it to the mortgage would be a good deal.

Use the loan amortization calculator to compare what you have saved vs how long it would have taken to pay off those credit cards.

Just keep these 2 things in mind.

First, if you pay off credit cards, it does absolutely no good if you go back an fill those cards up again. If you pay off 5 cards, tear them up! Keep one for emergencies, but just cancel the other 4 so that you are not tempted.

Second. When you consolidate debt you are now financing that credit card debt for 30 years. Ouch. If you have no intention of working on paying off that debt, consolidating the debt may very well not make sense to you.

Taking Cash out
Whether it makes sense to refinance to take cash out is usually a comparison of taking a new mortgage versus taking a second mortgage or Home Equity Loan.

You already know you want the cash or have a need for it, the question is only which way makes sense.

If you can lower the interest rate on the first mortgage, it absolutely makes sense to just do a complete new mortgage with extra cash.

If the rate will go higher, don't increase the payments on your original balance just to get some cash, take that second mortgage by itself.

Always Shorten The Length of The Loan to Save the Most Money
This should probably be first on the list because as far as I am concerned this is the number one way to save money on a refinance. If you can cut off years of payments for the same payment per month, it is nearly impossible to save enough per month to make up the difference.

Going forwards is much better than going backwards.

For instance, if you had a $175,000 mortgage that you had paid on for 5 years at 7%, the balance on the loan would now be $165,000. Interest rates are now at 5.5%.

Many people will go for the refinance at 5.5% for 30 years because it would save them $227 per month. This is a great savings every month, no doubt. However if you were to keep the loan the whole 30 years, the actual savings would only be $11,880 because of adding the extra 5 years. Hmmmm......

But guess what? If you took out a 20 year mortgage at this time, the interest rate would be at about 5.375% and the payment would be $41 per month cheaper.

You do not save as much per month, but with the 20 year mortgage, the savings would come to $76,840 in interest payments!!

If you only look at the monthly payments, you are missing the big picture of possible savings when you refinance. Always consider shortening the length of the loan.

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