In recent posts Beth gave advise on using the equity in your home to consolidate debt. Great advise, by the way. I wanted to take it a step further and talk about simply refinancing your home. The current mortgage interest rates are very appealing to a homeowner. If you are a homeowner who has good credit and the right amount of equity in your home, why not refinance and get that lower rate? Well, the main reason is that refinancing isn’t free. These are your closing costs. These cost fluctuate based on how much mortgage debt you are refinancing. Generally, closing cost are ADDED to your current loan balance, increasing the amount you owe. You may pay for a small portion such as the credit report and appraisal. Everything else is added in unless you have the cash to pay it.
So here is a simple example. Robin has a mortgage loan of $100,000. She is going to refinance her home. The bank gives her a Good Faith Estimate reflecting closing cost of $1200. When she refinances her home, the new loan amount will be $102,000.
No big deal, right? Maybe…maybe not. The true deciding factor in refinancing your home is what value will you get for the cost. How long will it take you to recoup the cost of refinancing your home? If it is less than 2 years, I consider that a good value. Simply take the total cost and divide it by the principal only portion of your loan payment. Let’s use Robin again. Her cost are $1200 and the principal only portion of her NEW payment is $200 a month. It will take her 6 months to recoup her costs. That’s a good value.
This leads me to the lower interest portion. Consider not only the lower payment going forward but all of the interest you have paid in the past. That is money you will never see again. How then do you insure you fix this in the future? Pay extra on your mortgage loan. In Robin’s senario, she owned her home for 8 years before refinancing. Although her mortgage payment will drop more than $200 per month by refinancing, she has committed to paying an additional $75 per month to the principal. This method keeps her on track for paying off her mortgage in about 30 years instead of 38 years.
The best thing you can do before you refinance your home is to do the math first. It needs to make sense for the long term just as much as it does in the short term.