Deciding When To Refinance Your Mortgage

I was recently propositioned by my original lender. He offered me a new 30-year fixed mortgage at 5.25%, which is a full 1% lower than my current 6.25%. This would save me roughly $200 on my monthly payment. Sounds great right? The catch is that I would have to pay closing costs to the tune of $1,600. Also, I would be starting over again on a new 30-year fixed mortgage.

Factors Affecting Refinancing Your Mortgage

• Interest Rate – Obviously, the major driving force in refinancing a mortgage is the interest rate. Everything else equal, the lower the interest rate, the lower the monthly payment. The sudden increase in mortgage refinancing inquiries is due to the dropping interest rates. The current national average for interest rates on a 30-year fixed mortgage is 5.27% via bankrate. There’s a common misconception that you only refinance your mortgage if you’re lowering your interest rate by 1-2%. Really, what it comes down to is how long until you reach your break even point.
• Closing Costs – Closing costs are the major drawback when considering whether or not to refinance your mortgage. Closing costs can be as high as 2-3% of your loan amount and they can be completely waived. Also, you can use negative points, which involves a higher interest rate, to cancel out your closing costs.
• Break Even Point – Your monthly payment and closing costs effectively determine your break even point. To determine your break even point you take your monthly payment savings and divide it into your closing costs. This will tell you how many months worth of payments will transpire before you recoup your closing costs. After determining how long it will take to reach your break even point, all you have to do is think about how long you plan on keeping your mortgage and evaluate based on your current financial needs.
• Remaining Length of Mortgage – When you refinance your mortgage you are agreeing to take on a brand new mortgage. You are not keeping your old mortgage with a new rate. If you have already made 5 years or 15 years of payments do you really want to agree to 30 more years? That may not sound like a good idea, but you can take your monthly savings with the lower rate and add it in as an extra principal payment. Also, you can always try to refinance your loan into a shorter term loan.
• Type of Current Mortgage – The type of mortgage can be a defining factor when deciding to refinance. You might have enough equity in your property to refinance into a 15-year fixed rate mortgage and save some money on interest payments. You might have an Adjustable Rate Mortgage (ARM) where you want to refinance into a fixed rate mortgage. If this is the case, you might even take a higher interest rate than your current ARM rate because the interest rates will raise in the future.
• Prepayment Penalties – I don’t know how frequent prepayment penalties are a factor for mortgages. I don’t have a prepayment penalty associated with my mortgage. These penalties are used by lenders to make sure they don’t lose out on the interest they feel they are entitled to since every extra payment on principal results in less interest earned by the bank. If you do have a prepayment penalty just add that to your closing costs when determining your break even point.

Conclusion

I decided not to take the refinancing deal from my original lender that I described above, because I did not like my first experience with him and I feel like I can get a lower rate. Although, my break even point with that deal was only 8 months, which is good considering I plan on staying in my condo for at least 5 years.

I don’t have a prepayment penalty and I don’t have to worry about my current mortgage as I’ve only made one payment. My original lender sold my mortgage to Wells Fargo, who I have been very happy with so far. I will most likely look into refinancing through them to give them a chance to keep my business. If I don’t find an acceptable break even point I will start looking around at other banks.