With the Federal Reserve setting a target interest rate of 0% on certain types of loans and the housing market being in a near depression, mortgage rates are reaching lows that have not been seen in the last five years. This has created a great opportunity for home-owners with mortgages that have a 6% or above interest rate which could potentially save homeowners thousands per year. However, refinancing does not make sense in all situations, so before going out and visiting a mortgage broker or your local bank, crunch some numbers and make sure that it makes sense in your situation.
Currently (as of February, 2009), homeowners with reasonably good credit can get a 15 year fixed-rate mortgage at approximately 4.85%-5.00% interest. For a 30 year fixed rate mortgage, the interest rates are sitting at about 5.25%. If you have a mortgage that’s above 6%, you are a potential candidate for a refinance.
Let’s take a look at an example. Let’s say that a home-owner has a mortgage of $150,000 at 6.5%. If the homeowner could refinance their loan and get a new loan at 5.25%, they would save the difference in the interest rate per year. So instead of paying $9,750 per year in interest on their loan, they would only be paying $7,875 on their loan, resulting in a net-savings of $1,875 per year or $156.25 per month.
Typically, you should look for a par quote that has zero points (prepaid interest) and no origination fee. This will give you a balanced few of how much you should really save. If you have to pay closing costs up-front or points, you’re essentially paying money up-front to save money later on. This can still make sense, but then the math is a bit harder to calculate.
In the event that you are looking at a loan which has points or closing costs, you take the dollar amount of closing costs, and divide it by the amount of money that you would save per month. This will tell you how many months it will take you to break even. If you had to pay $3,300 in closing costs to save $150 per month, you would break even after 22 months, and everything after that would be profit.
The average mortgage will last anywhere from 5 to 7 years in the United States, because people pay off their homes early, they move, or they refinance. If your break-even point is anywhere in the range of three to four years or more, it’s probably not going to be worth it to refinance, because you may be out of your mortgage by the time doing a refinance would actually save you money.
There’s also the consideration that doing a refinance can be a bit of a paper-work hassle. If you’re not going to save at least half of a percent in interest each month or if your break-even point is three or four years down the road, it’s probably just best to stick with the loan that you have now and ride it out. In the event that you can get a much better interest rate than you currently have and you’ll break even after a year or two, then a refinance might be in your future.