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How to Decide When to Refinance Your Mortgage

Written by Nickel - 20 Comments

I just got an e-mail for our mortgage broker saying that rates have dropped a bit since we closed on our house about a year ago, and offering to refinance our mortgage (i.e., remortgage) with no cost to us. Here’s how it would work…

The 30-year fixed par rate (i.e., the rate without paying points) is currently 5.875%. If we take the higher rate (6.125%) we’d get -0.75 points which would offset the closing costs. Nothing additional would be rolled into the mortgage balance; we would simply refinance the existing balance into a new mortgage. We would, of course, have to bring additional escrow funds to the closing table, but we’d then get a refund of our escrow account from our existing mortgage, so that would be a push.

The bottom line here is that we can shave 0.25% off our mortgage rate for free. The only downside is that we’d be resetting the mortgage ‘clock’ to a full 30 years. However, we’re currently only about 9 months in). It’s a no-brainer, right?

Deciding When to Refinance

First off, note that I’m ignoring taxes and insurance for the sake of simplicity — those values will be the same under either scenario.

For starters, our original mortgage balance was $175k. At 6.375% over 30 years, that works out to $1092/month ($393,120 over the life of the loan). However, we’ve been paying an additional $150/month toward principal. Assuming that we continue this for the life of the loan, we’ll pay it off about eight years early for a grand total of $323,665 (a savings of $69,455).

If we were to go ahead with the refinance, we’d be rolling our current balance ($172,136) into a new mortgage at 6.125%. Over 30 years this works out to $1046/month, or a total of $376,560. Assuming that we keep our payments the same, however, we’ll be overpaying by $196/month ($150 + the $46/month savings from the refi), that figure drops to $299,836, a savings of $76,724. However, we’ve already paid nine months into our current mortgage, so we can’t neglect that in our total cost figures. Nine months at $1,092 + $150 = $11,178. Thus, we’re looking at a total cost of $299,836 + $11,178 = $311,014.

Comparing the two scenarios reveals that we’ll come out about $12.5k ahead if we opt for the no-cost refinance. Of course, these sorts of calculations are only as good as your assumptions, but these scenarios are as realistic as I can make them. You can also try plugging numbers into a refinance calculator to see where you come out.

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Published on March 21st, 2007
Modified on July 10th, 2010 - 20 Comments
Filed under: Mortgages

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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20 Responses to “How to Decide When to Refinance Your Mortgage”

  1. 1
    Papa Rage Says:

    Yes but your new payment after the refi is $29 less than your current payment. So how do the numbers come out if you continue to pay what you are paying now (i.e. $179 extra a month ($150 + $29)

  2. 2
    nickel Says:

    Papa Rage: You’re absolutely right, and I also had another error in the math, so the payment is $46 less per month (creating a new overpayment of $196). I’ve fixed everything, and the outcome is now quite different. Thanks!

  3. 3
    Clever Dude Says:

    Got any advice for people who have a mortgage through a bank that doesn’t have no-cost refinancing?

    I have a 5/1 interest only loan, and I’m about 2.5 years into it. I researched refinancing a few months ago and was just a few signatures away from closing, but the costs were just too high so I balked.

  4. 4
    Blaine Moore Says:

    Nickel,

    I was going to point out the flaws in your math and your assumptions, but Papa Rage and yourself beat me to it!

    One thing to note on your refinance is that you will probably end up with a month without a mortgage payment. Save that money up for an initial overpayment your first month, which will also save you a bit on the interest.

    Now, what would your costs come to if you paid a point into it rather than taking a negative point(ish) and got the even lower rate? If you plan on living there for a while, spending the two grand now might enable you to pay your mortgage down even faster, as long as that extra 1.7k won’t hurt too much in the short term.

  5. 5
    CreditNine.com Says:

    Um nickel I probably wouldnt do it, seems as though its not a much of a savings you would be getting.. but thats me..

    Do you pay monthly your mortgage or do you do the dave ramsey thing and pay every 2 weeks so that you get an extra payment in a year leading to paying off your mortgage 5 years earlier?

  6. 6
    nickel Says:

    We pay monthly, but with a $150 overpayment. This equates to about 1.5 extra payments per year. Paying every two weeks is a game for those that don’t have the resolve to overpay their mortgage. The way we’re doing it, we’ll end up paying it off about 8 years early. I’m curious, though… Why isn’t $12,500 enough savings to make it worth the trouble? Again, there’s absolutely no cost involved here, so all I’d really be giving up is a small amount of time to go to the closing.

  7. 7
    nickel Says:

    Clever Dude: There’s nothing magic about the no-cost aspect… It’s just that we’ll take a higher than market (but lower than our current) rate and the negative points will cover the closing costs. You could do this yourself by taking the negative points and then paying for the closing costs. In our case, the broker is offering to shuffle this stuff for us, but you could do it on your own. The only advantage to doing it our way is that the broker will eat the excess costs if they go beyond the amount of the negative points. I’ve run the numbers, and it will be tight, but I don’t think there’s any way we’d come out ahead by taking the negative points in cash and then paying the closing costs out of pocket. If anything, we’ll come out slightly ahead doing it directly.

  8. 8
    Ramo Says:

    What about running the calculations with the 5.85% refinance? (What are the closing costs associated with that refinance?) That may make even more financial sense in the long run even if you have to pay for closing costs up front.

  9. 9
    FMF Says:

    Ahhh, the joys of not having a mortgage. ;-)

    Looks to me as if you’re thinking of it the right way (now) and if you can pay less for no cost, why wouldn’t you?

    In addition, you may want to think about adding even more to your pre-payments to save even more.

  10. 10
    plonkee Says:

    I take it that you’re going to refinance, not looking a $12.5K gift horse in the mouth.
    When I ran the numbers on your mortgage through dinkytown, if you went for the 0 points option, the refi payment would be $1035, leaving a $207 overpayment, and a total mortgage cost (excluding the 9 mos already paid) of $297660. Which would mean that closing costs would need to be less than $2176 for this to be worthwhile.

  11. 11
    nickel Says:

    Plonkee: I just ran the numbers and came up with something a bit different… At 5.875% (which requires us to pay closing costs), the total repayment is $1018/month (maybe you used $175k as the loan amount? The refi would be for $172,136). At $1018/month, our overpayment would grow to $224 ($150 + $74) which would results in a total cost of $288,559. Adding the nine months back in brings us to $228,559 + $11,178 = $299,737. This is slightly over $11k better than the no-fee option, and $22k better than doing nothing. Of course, the savings come on the back end when the mortgage is paid off early, so we also have to consider what our closing costs would be worth in the future. Assuming $2k in closing costs and projecting out 20 years at 5% (ignoring taxes) we end up with a future value of the closing dollars at $5306, which is about half the additional savings of paying for the refi.

    Now I just need to dig out our closing papers from 10 months ago and figure out exactly how much we can expect to pay in closing fees.

  12. 12
    D Says:

    Just want to suggest you call some other brokers and bankers and ask if they could refi your mortgage at the current rate with no fees.

    You just don’t know what you can receive until you ask. Sometimes, they do wave all costs, because they make the interest off of you.

    At least this has been my case.

  13. 13
    mbhunter Says:

    From what you tell me it seems to be not a bad deal, though you’re stretching that $12.5k savings over 30 years! That’s maybe one dinner out a month (just you and the Mrs., not the four boys, unless you go to McDonald’s), until inflation turns it into an extra box of cereal a month in about 2030. Savings is savings, but that doesn’t seem like something I’d be dancing in circles about.

    Also, “no-cost refinance” might just be the costs they have control over. Are you sure that other folks won’t be charging you fees?

    If you do it I’d stay on top of them to make sure they’re moving on it. I did a refi from 30-year to 15-year (and shaved off a percent in the process) but they dragged it to the bitter end and I ended up signing the refi without knowing exactly what the final closing costs would be. Some lenders have a way of using time pressure against you.

    For what it’s worth! ;)

  14. 14
    nickel Says:

    mbhunter: Good point on additional fees, and that’s the first thing that I asked. The broker is offering to use the negative points to offset the *full* closing costs, including third-party fees. If the negative point fall short, he’ll eat the difference (and yes, I’ll be sure to get that in writing). Mortgage brokers get a commission from the lender beyond what they hit up the borrower for, so they’ve got some wiggle room to absorb costs.

  15. 15
    Deejay Says:

    Nickel Dude,

    My take is always do the no-cost option. This way if and when rates go down again, you can refinance again and push your rate even lower.

    When I played this game starting in 2000, rates were falling a point every year or so. I refinanced 3 times in two years, each time a no-cost and each time lowering my rate. If I had paid points, I would have lost that “investment” when i refinanced 6-9 months later.

  16. 16
    JLP at AllFinancialMatters Says:

    Nickel,

    One thing you are leaving out of the equation is the opportunity cost of that extra money you are applying to your mortgage payment. Sure, you may save yourself some interest by paying your mortgage off early. BUT, what you are you losing out on by NOT allocating the extra payments somewhere else?

    In other words, you’re not really “saving” $76,000 by paying off your mortgage early.

  17. 17
    nickel Says:

    JLP: Very true, although that has more to do with how we choose to spend the difference from our reduced payments (pay down mortgage vs. invest) as opposed to whether or not we should should refinance in the first place. If we choose not to pay down our mortgage early, we could still refinance and have additional money for investing.

  18. 18
    Shawn Says:

    If you are planning to settle for a fixed mortgage rate, research on the best fixed mortgage rate. You can ask your broker about it or a mortgage quoter.

  19. 19
    real estate blogger Says:

    Ask yourself basic questions first. Do you know the current home loan mortgage rate? Are you willing to carry such burden? Are you in favor of the current payment terms as well as the payment period? Do you think you can sustain that? If so, then you may be ready to refinance.

  20. 20
    James Says:

    We were told to wait to refinance till the market stabilized a bit-with all the bankruptcies, it’s putting us all at risk. What if our lender goes bankrupt? What then?

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