A mortgage refinance is a common financial move for homeowners trying to get into a better loan situation. It involves getting a new mortgage to take over for your current loan. Common reasons people refinance include a better interest rate, lower monthly payments and cashing out on home equity.
Mortgage rates fluctuate over time based on a variety of economic factors. If rates have dropped since you got your initial mortgage, it may make sense for you to get a new mortgage to replace the current one. The process is relatively simple as you just need to lock in a rate with your lender and complete the loan application process as you did with your initial loan. To decide if a refinance is a good move, you need to look at it like an investment.
On the surface, a refinance may seem like a no-brainer. However, you need to consider the closing costs you usually have to pay to get one. Just as you paid fees to your lender, title company and appraiser to get your initial mortgage, you have to pay them on a refinance in most cases. This is essentially your upfront investment in the new loan. Closing costs vary based on the value of your loan and geographic location, but typical costs are just over $4,000 on a $200,000 loan, according to the 2011 Bankrate.com annual survey of closing costs.
The most straightforward way to justify a refinance is to compare your potential savings to the refinance cost. The monthly interest savings on the new loan is basically your return on investment. Assume you invest $4,000 in closing costs and get a loan with a monthly payment that is $200 per month lower. It would take 20 months of savings to cover your investment. In a simple refinance consideration, you can justify the loan's cost if you intend to stay in the home at least 20 months.
Some people justify a refinance based on other reasons. If you are overwhelmed with other monthly debt obligations, it may help you get out of trouble to refinance and spread your loan back out over a 30-year term. This lowers your monthly mortgage payment and allows you to put more money toward other debt. Additionally, you could get a refinance that pays more than your current mortgage balance, allowing you to take cash out of the equity in your home. If you have a good reason to do this, it may make sense aside from the financial logic.
Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.