My husband and I just refinanced our mortgage and were able to lower our interest rate by 1.25%. We bought our house in December 2005, so we’ve lived in it just over 2 years. We plan to stay in this house at least another couple of years so refinancing made sense for us. We will quickly make up in monthly savings what we spent in closing costs. In fact, because we shopped around and told our current lender we were shopping around, they got us an incredible rate AND waived our closing costs. I was shocked to be honest. I suppose right now, lenders will fight very hard to keep customers that are making their monthly payments. So, how do you know if refinancing makes sense for you? There are basically 3 things you’ll need to know; If you’ll have a prepayment penalty, the amount of your closing costs, and your monthly savings.
Let’s start with the prepayment penalty. Your lender might charge you a fee if you refinance, sell your home early, or in some cases, make a significant payment against your principal. If you will have to pay a fee, it doesn’t necessarily mean you shouldn’t refinance. You’ll just need to know the amount of the penalty so you can add it to the other fees you’ll probably be charged.
Once you know that, talk to a lender to find out how much money you will save each month by lowering your interest rate. There’s really no magic number here, you will be the one to decide. If money is really tight, having an extra $50 each month might make a big difference for you.
Finally, get an estimate of closing costs from the lender. Ask them to shoot towards the high end. I always think it’s better to find out your closing costs will be less than you were expecting than the other way around. Keep in mind you can almost always add your closing costs to your mortgage so you don’t have to come up with several thousand dollars on the spot.
With all the information you’ve gathered, you need to find your break even point, or the point where the extra fees are offset by your savings. Here’s an example:
The lender tells you your closing costs will be $3,000 and after lowering your interest rate by 1% you will save $100 per month. Now divide $3,000 (plus any prepayment penalty) by $100 to get 30. In 30 months, your monthly savings will offset the fees you were charged. If you plan to stay in the house at least 2.5 more years, it’s probably worth it to refinance.
It’s obviously a very personal decision and there are no hard and fast rules. In really great real estate markets with high annual appreciation, I’ve heard of people focusing solely on their monthly savings because they figure they will more than pay off any fees when they are able to sell their home for much more than they paid. Talk to a lender or realtor that you trust and do what feels right for you.