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You may think that refinancing is a big pain
for a small gain, but a recent MotleyFool.com article says otherwise.
Refinancing can mean big savings for you and your family.
You have probably heard your coworkers, family or
friends talking heatedly about it whenever interest rates drop:
to finance or not to refinance? Why is this? Lower interest rates
typically mean lower mortgage loan rates. If you refinance your
current home loan at the lower rates, you could save a little
each month. But, you may ask, what about the hassle? Will my savings
be worth the costs up-front? We will broach these topics and more.
Break Out the Calculator
With regard to finances, especially personal finances,
everyone wants an easy “rule of thumb.” A common one
with regard to refinancing is to only get serious about refinancing
if you can get a minimum interest rate improvement of two percentage
points from your existing mortgage. A rule of thumb like this
can be misleading, however. According to MotleyFool.com, “the
interest rate cut required to come out ahead will vary dramatically
depending on how long you plan to hold the new mortgage, how many
years you’ve already paid on the current mortgage and the
increasingly available opportunities for cutting closing costs.”
Therefore, it is always a better idea to take numbers
that match your unique situation (such as what rate you’re
currently paying and how long you have already held the loan)
and input them into an online calculator. One such calculator
can be found on MotleyFool.com. You can also use such calculators
as guides for evaluating lenders. Once you receive data from lenders
and put it into the calculator, you will get expected closing
costs. This is what your interest savings has to beat.
Calculating Refinancing Savings
Next, you’ll need to find out how much you
are looking to save in mortgage interest payments after refinancing.
There is one catch to this somewhat clear-cut calculation: to
cover your closing costs, you have to pay today’s money,
but the interest savings you will realize will accrue over time.
There is a simple rule called “the time value of money”
that dictates that tomorrow’s money isn’t as valuable
as today’s, mainly because of interest earnings lost. This
rule therefore means that it makes sense to convert your future
interest savings to today’s dollars in order to have a fair
comparison to the closing costs you’ll have to pay. This
is especially true if you are planning to keep your mortgage for
a long time.
Sound confusing? Don’t worry, MotleyFool.com
has yet another calculator that will give your brain a rest: an
“am I better off refinancing?” calculator. If you
have already compiled your information to use the first calculator,
you are most of the way there if you want to use this second calculator.
You will just need to add information about your existing mortgage
to calculate what a new mortgage would have to beat.
Other Reasons to Refinance
Many homeowners, especially first-time homeowners,
have adjustable-rate mortgages (ARMs). You may be uncomfortable
with the uncertainty of payment amounts with an ARM and would
like to switch to a fixed-rate mortgage. Or, you may have found
an ARM with a lower interest rate or improved features, such as
a payment cap.
If you choose not to refinance, it might still be
worth it to ask your current lender to modify your current loan
to best suit your needs.
A Final Warning
Prepayment penalties. An often hidden, ugly
aspect of lending. A prepayment penalty is a penalty assessed
when you pay off your loan early (such as when you refinance and
another lender pays off your loan). If this penalty is large enough,
refinancing may not be prudent until the prepayment penalty period
expires. Look over your existing loan documents or ask your current
lender for clarification before diving into refinancing head first.
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