When does refinancing really pay?

Most people refinance to get a lower interest rate. They figure that a lower interest rate will automatically translate into saving money, but this may not be completely true. You also have to consider the term for the new loan. If you lower your interest rate by 2% but the life of your loan increases from 15 to 30 years, you're not actually saving any money because you're paying more in long-term interest. Refinancing can definitely lead to significant savings, but it's most likely if you're able to reduce the interest rate and the loan's term is the same or shorter.

Closing costs are another expense you need to consider. In order to determine your "break even" point on a refinance, you should divide the closing costs by the reduction in your monthly payment. In other words, if it costs you to refinance, and your mortgage payment is less, you divide 2000 by 100 and that's how many months it will take you to recover your costs.

Here are some good reasons to refinance:

  • you're saving interest long-term
  • you're using the money you'll get back to pay off high-interest credit cards or other debt
  • you'll be in the house long enough to recover your closing costs
  • you have an ARM that you're converting to a fixed-rate mortgage

There may be other situations in which refinancing is a good option, depending on your particular situation. Consult with a mortgage broker or financial advisor before making a final decision.