Is It Wise to Refinance My Mortgage?

The old rule of thumb to determine this was the 2-2-2 rule. This stated that if you have been in the home for 2 years, plan to live in it for another 2 years, and the new interest rate is at least 2% below your existing mortgage interest rate, then refinancing will make financial sense. This is still pretty good advice, but with average prices of homes today as high as they are, even considering the drop in home prices many areas of the country have undergone, refinancing may make sense with an interest rate of even 1% less than your current rate, or possibly even less than that. There is a fairly easy way to calculate if refinancing your mortgage to a lower rate makes financial sense, and rates available today have not been possible for decades.

First of all, you must realize that you will not get a loan for 100% of the value of the home. Something like 80% is more realistic. So you must have enough equity in the home such that when you borrow 80% of what your home is worth today, you can pay off the existing mortgage. If you can’t then you won’t qualify for this loan unless you come up with some other cash.

Assuming you do have the necessary equity, the next step is to calculate your break even period. This means that you need to figure out how many months it will take to pay off the costs of obtaining the new loan. This will probably be at least several thousand dollars. You can simply phone a mortgage broker and explain your situation and ask him or her to estimate how much the refinance charges would typically be in your case. To get an exact figure you would need to fill out an actual loan application in order to obtain a Good Faith Estimate. With this you will know how much your refinance charges will be. The mortgage broker will probably push you to fill out the loan application in order to make money on the deal if you do decide to go through with the refinance process,

You also need to find out what your monthly payments will be on the new mortgage. You then subtract this lower figure from your current payment, and you will know how much less your new payment will be and how much you will save each month. Divide this savings figure into the cost of obtaining the new mortgage and you will know how many months it will take for your new lower payment to pay for the costs of obtaining the loan. This is the break even period. If this time period is 24 months or less, it will probably make sense for you to refinance, assuming you will stay in the home that long. If it is possible you will be moving before that period of time, forget about refinancing.

People have other reasons for refinancing a mortgage than just getting lower monthly payments. You may want to get out of an adjustable mortgage and get into a fixed one where the payments will not change. Or you might want to go from a thirty year loan to a fifteen year loan to pay off your home quicker, for example. Most people are looking to have lower monthly payments, however, so the above calculations will give a good idea if mortgage refinance makes sense for them.