Refinancing your mortgage is often seen as a strategic move to lower your monthly payments or save on interest over the life of your loan. However, the decision to refinance isn’t always as straightforward as it seems.
While many homeowners consider refinancing solely for the purpose of lowering their interest rate or monthly payments, the real reasons and benefits might be more nuanced.
To Refi or Not to Refi
When it comes to refinancing, the primary goal isn’t always just about saving money each month. There are other critical factors to consider. If your primary reason for refinancing is to cash out and pay off debt, that’s a different scenario and warrants its own discussion. Here, we’re focusing on rate and term refinancing, which aims to change or improve your rate or loan term.
Note: the word “term” in mortgage talk means the duration of the loan. The most common “term” is the 30 year fixed rate loan.
Another common “term” is 15 years. Basically, the word “term” means the duration that is used to calculate the monthly payment.
The longer the term, the lower the payment. For example, the monthly payment for a 15 year term will be higher than a 30 year term because the mortgage loan will need to be paid off in half the time.
What This Isn’t: Need-Based Refinance
Because these are “need-based refinances” like:
- cash-out
- debt consolidation
- HELOC, or
- home improvement,
the approach differs. Sometimes, it’s important to lower the payment but not necessarily save on interest. This could be to create cash flow or lower the debt obligation for the household.
For example, you might refinance from a 15-year to a 30-year term to lower your payment, or you might “restart the clock” on a 30-year close to lower the payment, even if you’ve been in the home for a few years.
Understanding Savings and Interest
If you’re truly refinancing to save money on interest, you need to take a closer look at the bigger picture. This involves recreating your current mortgage scenario as if you were starting fresh and comparing it to the new terms post-refinance. The key is to determine how many years it will take for the refinance to break even.
One of the major factors to consider is the total cost of the new loan versus the remaining cost of your current loan. This includes the interest you’ll pay over the life of the loan and any upfront costs associated with refinancing, such as closing costs, appraisal fees, and other charges.
The Break-Even Point
Let’s walk through an example. Suppose refinancing saves you $3,000 a year in interest. If the cost to refinance is $10,000, you need to divide $10,000 by $3,000, which gives you a break-even point of approximately 3.3 years.
On the other hand, if you’re only saving $1,000 a year in interest, the break-even point would be 10 years. This extended time frame might not make sense for many homeowners, especially if there’s uncertainty about how long you’ll stay in the home.
Mark’s Rule of Thumb
In my opinion, if you can’t make back the cost of refinancing within 3 to 4 years, it’s too hard to predict the future benefits. There is, however, some grey area.
For instance, if you plan to be in your home for a long, long time because your kids are in school and will be there for at least 8 more years, refinancing might still make sense. Conversely, if your children are in high school and you anticipate becoming an empty nester in about 5 years, refinancing might not be the best decision.
Personalized Decisions that Impact Break Even
Ultimately, the decision to refinance is highly personal and depends on your unique circumstances. Here are some questions to consider:
How long do you plan to stay in your home? If you’re planning to move in a few years, the long-term savings from refinancing might not outweigh the initial costs.
What are your financial goals? Are you looking to save on monthly payments, or are you aiming to reduce your overall interest costs?
How does your current mortgage compare? Recreate your mortgage scenario and see the exact impact of refinancing on your financial situation.
By considering these factors and doing a thorough analysis, you can make an informed decision about whether refinancing is right for you.
Additional Considerations
It’s also important to consider the current market conditions and your credit score. If interest rates are significantly lower than your current rate, and you have a strong credit profile, you might qualify for better terms.
However, if your credit has taken a hit since you took out your original mortgage, you might not get the favorable rates you’re hoping for.
Another key factor is the loan term. If you’re far along in your current mortgage, restarting the clock on a new 30-year term might not be advantageous. Instead, you might consider refinancing to a shorter term, like 15 or 20 years, which could help you save on interest without extending your payoff date too far into the future.
Mark Pfeiffer
Branch Manager
Loan Officer, NMLS # 729612
(972) 829-8639
MortgageMark@MortgageMark.com
What Makes Us Different: The REAL Break Even
It’s not just about comparing monthly savings to the costs. It’s all about the REAL BREAK EVEN. To truly understand the benefits of refinancing, you need to compare the existing loan to the new loan. Here’s how:
- Determine Actual Savings (Interest and MI): Don’t get fooled by escrows or MI.
- Determine Cost: Understand that cost and money out of pocket are not the same.
- Calculate Break Even
- Determine if it’s right for you: Mark’s rule of thumb is 3 years, but there are exceptions to the rule.
Learn More with Mortgage Mark
For more insights on refinancing and other mortgage-related topics, check out our refinancing guide and explore our blog for the latest tips and advice.
Refinancing is not a one-size-fits-all solution. It requires careful consideration of your current financial situation, your future plans, and how the numbers add up. So, before you jump into refinancing, take a step back and evaluate all the factors. It might just save you from making a decision that doesn’t align with your long-term financial goals.
For personalized advice, always consult with a mortgage professional who can guide you through the specifics of your situation.
Our team at Mortgage Mark is here to help you every step of the way. Contact us today to discuss your refinancing options and find out what makes the most sense for you.
Mark Pfeiffer is a Mortgage Loan Originator with CMG Home Loans and a veteran of the mortgage industry since 2003. Mark is responsible for ensuring all loans originated by the Mortgage Mark Team offer competitive terms and close on-time.
We assist clients with all type of mortgage loan programs