Real Estate Financing and Investing/Does It Pay To Refinance Your House

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Whether refinancing is worthwhile depends on the costs of refinancing and the time required to recoup those costs through low mortgage payments. The costs of refinancing are the closing costs, which can vary widely. Closing costs include:

  • Title search
  • Insurance (such as hazard, title, and private mortgage insurances)
  • Lender`s review fees
  • Buyer`s loan points
  • Re-appraisal fees
  • Credit report
  • Escrow fees
  • Lawyer fees
  • Document preparation fees, judgment reports, notary fees, and recording fees.

To get a rough estimate of the closing costs, take the costs of refinancing (3 to 6 percent of the outstanding principal) and multiply it by the amount of the loan.

Example:
If the loan amount is $100,000 and the cost is, say, 5 percent, the closing costs are $5,000.

Rule of thumb: To refinance successfully, you should plan on staying in the house for at least three years and should be able to reduce the rate paid on the mortgage by at least two percentage points.

  • If you are a fixed rate mortgage holder, you might look for another fixed rate home loan at least two to three percentage points below the mortgage currently held.
  • If you have an adjustable loan, you might consider what the expected rate on the adjustable rate mortgage (ARM) will be several years hence. If the current rates on fixed mortgages are substantially below the expected rate on the ARM, it might pay to refinance.

Rule of thumb: The factor to consider when refinancing is the amount of time it will take to recoup the costs of refinancing.

Example:
Assume that refinancing is $75,000. A 14 percent mortgage involves closing fees of $3,750, and the new interest rate is 10 percent. At the new rate of 10 percent, the monthly payment on a 30 year fixed loan would be $658. That is a savings of $231 from the monthly payment of $889 required on a 14 percent loan. Dividing the total refinancing cost of $3,750 by $231 gives a recovery period of about 16 months. Table 2 below illustrates the monthly and yearly savings from refinancing to a 10 percent 30 year fixed rate mortgage for $75,000.

Table 2. SAVINGS FROM REFINANCING

Present Mortgage Rate Current Monthly Payment Monthly Payment @ 10% Monthly Savings @ 10% Annual Savings @ 10%
12.0% $771 $658 $113 $1,356
12.5% 800 658 142 1,704
13% 830 658 172 2,064
13.5% 859 658 201 2,412
14% 889 658 231 2,772
15% 948 658 290 3,480