What You Need to Know About Refinancing
Is Refinancing for You?
If you're going to save money on your interest rate, and you don't have to pay your closing costs out of pocket, you should always refinance, right?
Not necessarily. Closing costs that are rolled into your loan are still closing costs, so you want to take a look and see how much they are. If you think you're going to move fairly soon -- say, in the next two years -- it's probably not worth incurring the fees.
The Hidden Costs of Refinancing
Paying interest for those extra years can really add up. Let's say you bought a home for $500,000 in 2006, and took out a $435,000 mortgage at 6 percent. Your average monthly payment would be $2,608, and over the life of your loan, you'd expect to pay nearly $504,000 in interest.
After holding the mortgage this long, you probably owe $400,000. If you refinanced that now at 5 percent, your monthly payments would drop to $2,147.
Wow, you might be thinking, I'm saving $461 a month!
You must, however, consider the amount of interest you're paying to extend the loan. With your new loan, you're paying $373,000 in interest, but you'd probably already paid $136,000 in interest to get to this point, resulting in a new total of $509,000. That's $5,000 more. So, even though your monthly expenses look cheaper, refinancing has actually cost you money, because you're paying more money over the life of your loan.
How to Make the Call
There are interest-rate calculators you can tinker with, depending on your particular circumstances (I'm fond of the one at HSH.com). To start, though, consider two rules of thumb:
- Do consider refinancing if you can drop your interest rate by at least one point (say from 6 percent to 5 percent)
- Don't refinance if you're already six years (or more) into your pre-existing mortgage.
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Originally published on LearnVest.com; republished with permission.
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