August 5, 2007
By Cam Nowlin
Contact: 512-698-7910
Texas Southern Lending
Houston Mortgages
Because of the complexities involved in refinancing, it can be difficult to shop for a mortgage refinance, or even to know whether refinancing is a good option. You can't really get the big picture without taking into account the interest rate, the closing costs, the terms of the old loan as well as the new, and the break-even point. Fortunately, a few fairly straightforward calculations can simplify things greatly.
Breaking Even 101
The most important calculation you'll make is the "break-even" point. In business, breaking even is the point at which profits equal expenses. How many hot dogs do you have to sell to cover the cost of your hot dog cart? The same holds true in a mortgage refinance. Your closing costs are your expenses, and the savings on your monthly payments are the profits. After a period of months or years, the savings on your monthly payment will equal what you paid to close the loan, and you'll begin to enjoy true savings.
Let's say that your closing costs equal two thousand "hot dogs," and you are decreasing your monthly payment by one hundred "hot dogs" each month. That means that in twenty months, you'll reach your break-even point and henceforth one hundred hot dogs a month will go into your pocket (no mustard please). If the break-even period is longer than you expect to be in the house, don't do it. It's that simple.
Breaking Even 401
However, this quick estimate leaves out a few important details. One is that if you refinance for a longer term, your monthly payment will be significantly lower, but your overall costs will be increased. If you are refinancing a thirty year mortgage with twenty five years left for a new thirty year mortgage, of course your monthly payment will be lower. However, when you take into account the total interest you pay over the lifetime of the mortgage, you may actually come out behind. This all depends on your new interest rate and how much you paid for closing. Make sure you look at the total interest paid over the life of the loan as well as the change in your monthly payment.
Some borrowers may actually choose to make higher monthly payments in order to shorten the term of their loan, and therefore save in interest payments overall. In this case, it's better to think of the break-even point as the point at which the total cost of your loan, including closing costs and interest, becomes less than the remaining costs on your old loan would have been. If you only take into account monthly payments, this sort of refinance would never be worth it. Instead, it's actually a very shrewd move for those who can afford it.
What about Closing Costs?
Closing costs are another item to watch. It's common to roll these costs into the new loan, so that they "disappear," but you're still paying them. Similarly, some lenders offer "no cost" refinance. What really happens with a no-cost refinance is that you pay a slightly higher interest rate in exchange for the lender covering your costs. The upshot is that you walk in, sign some papers and get a lower monthly payment. Either of these arrangements can be beneficial, as long as you are going in with your eyes open and the prices are not inflated because of their invisibility. If you are planning to stay in the home for a shorter period of time, a no-cost refinance, or one in which the closing costs are included with the loan might make sense.
When you've looked at all the options and finished your calculations, it's very possible that you'll find no benefit in refinancing. This is not surprising. You may have received a phone call from an excitable mortgage broker who thinks they can save you a bundle by refinancing your mortgage, but you're the only person who has all the information necessary to make this decision. Sometimes you can save a bundle by simply saying "no thank you."
