Refinancing a Mortgage

The three most important variables affecting this decision include the years left on the existing mortgage, potential closing costs, and even how much longer the borrower expects to live in their home. Understanding these variables will help everyone to make the right decision. Let's take a closer look at an example that demonstrates this point.

Example 1: Refinancing

In this first scenario, Ann is thinking about refinancing her existing home mortgage that has an initial balance of $200,000 at an 8.00% rate of interest. Furthermore, let's assume she has a 30-year mortgage, with 10 more years remaining on the loan.

Crunching through the numbers reveals Ann has about $121,000 of principal remaining on the loan. Let's say the current market is offering a 30 year, 6.00% refinancing loan to replace this mortgage.

The good news is that Ann's monthly payment will drop from around $1,470 to $720. But Ann is also going to be making payments for 30 more years. If she had stayed with her existing mortgage, she would have paid another $178,000, which includes $55,000 in interest charges. With the new mortgage, she will need to pay out another $260,000, of which $140,000 is interest charges.

In the above example, Ann has lowered her monthly payment, and has more money in her pocket; but over the long haul, she will pay significantly more.

Another important factor to consider is how long the owner plans to stay in the home. When refinancing an existing mortgage, it's very likely the borrower will have to go through a formal closing. That means paying closing costs associated with attorney services, title searches, title insurance, and loan applications. In order to recoup all of these fixed costs, the homeowner needs to stay in this location long enough to make the closing worthwhile.

The good news is that lenders will help borrowers work through these questions if they know what to ask. The following is a short list of questions to discuss with lenders:

• Considering all the fees and costs associated with refinancing my mortgage, how long do I have to stay in my home before I reach the breakeven point? (The breakeven point is where the savings are equal to costs.)

• What are the total of my payments and interest charges for the remainder of my existing mortgage versus refinancing?

Borrowers should also talk to their lenders about choices like prepaying their mortgage. This is a strategy that can help lower the long-term impact of refinancing.

Example 2: Prepayments

In the first example above, Ann was able to lower her monthly payment from $1,470 to $720. But this move cost her 20 more years of payments, and $85,000 in additional interest charges.

If Ann was disciplined enough to continue paying $1,470 each month, and applied the additional money to the new loan's principal, the 30-year mortgage would be paid off in about 8 1/2 years. This translates into roughly $22,000 in savings versus the 10 years left on the original loan.

The point we're trying to make is that borrowers need to be both creative and disciplined to reap the potential benefits associated with refinancing an existing loan. Don't be afraid to ask lenders to crunch through some numbers. Play out a couple of "what if" scenarios with the lender. The information received will allow the borrower to make a better decision.