Refinancing: Look Beyond the Lower Interest Rate

 

Homeowners often think that if interest rates drop that they should run out and refinance their property. While a lower interest rate can save you money, it doesn’t mean that a refinance is the right move for you. It’s important to evaluate several different factors, such as the long-term costs, the timeframe of your loan, the APR, the costs for refinancing and the length of time you expect to live in the home.

 

Long-term Costs

 

During the first half of your mortgage, you are primarily paying interest and very little goes toward reducing the principal balance of your mortgage. This means that every time you refinance, you go back to paying mostly interest as part of your mortgage payments. In the long-term, you end up paying more money when you refinance, even if you end up shaving off some money on your monthly mortgage payments.

 

Extends Your Loan

 

Every time you refinance your mortgage, you are starting your loan from scratch. If you have had your existing mortgage for five years, then you might only have 10 or 15 years left to pay on your loan. When you refinance into a new 15 or 30 year mortgage, you have now extended the amount of time that you have to pay on your mortgage.

 

Evaluate the APR

 

Besides the mortgage interest rate, you also need to evaluate the annual percentage rate, APR. The APR is the annual cost of borrowing money expressed as a percentage. The APR takes your mortgage interest rate and closing costs into consideration to reveal to show the true cost of borrowing the money for your refinance. This means that even when the interest rate on a mortgage is lower than what another lender is offering, the lender offering the lower APR is offering you the best deal overall.

 

Length of Time in the Home

 

If the home is a short-term home for you then a refinance might not be as beneficial as a long-term property. The best way to determine if a refinance is beneficial is to calculate a break-even analysis. Divide the total closing costs by the savings in your monthly payment.

 

This provides you with the number of months it will take you to recoup the closing costs. If you intend on living in the home for this timeframe or longer, then you will recoup the costs before leaving the home. If not, a refinance is not in your best interest.

 

Other Costs

 

Closing costs are not the only costs you have to factor in to the equation. Other costs include the prepaids you are responsible for paying. You are responsible for prepaying the interest on the mortgage. Additionally, the insurance and the taxes must be prepaid on the property. These costs should make it into your evaluation when deciding if a refinance is in your best interest.

 

Lower interest rates do not automatically equate to a time to refinance. You have to look at other factors beyond the interest rate to truly determine if a refinance is beneficial for you.