September 7, 2002
Mortgage rates are rising and there are still millions of borrowers who could save big money with a mortgage refinance. Refinancing will generally pay off if you can reduce your rate by at least 0.75 percentage points. With a much smaller rate reduction, closing costs are likely to make the savings minuscule or non-existent. Mortgage rates have increased by more than a full percentage point since the start of the year however, you still may be in a good position to refinance. If rates rise further — as is expected — more people could lose the incentive to refinance.
That means, if you are among the 3.8 million who could reduce your rate, it makes sense to act fast.
You don’t have to refinance into another 30-year loan. If your finances have improved and you can afford higher monthly payments you can refinance your 30-year loan into a 15-year fixed-rate mortgage, which will allow you to pay the loan off faster and also pay less interest.
Taking a look at your monthly savings is just one part of the refi equation, however. You also need to factor in the cost of switching out your loan and how long it will take you to recover those costs, or break even.
Just as with a purchase loan, you’ll have to pay closing costs on a refinance. These costs can include origination and applications fees, appraisal and inspection costs and title search fees. In all, closing costs can run between 3% and 6% of the total loan amount being refinanced. Because the potential savings are significant, you should at least find out whether a refinance makes sense right now.
You can determine your breakeven point by dividing your total closing costs by the amount you’ll save each month. The result is the number of months it will take you to recoup the refinance cost and start saving money. The less time it takes to break even, the more sense it makes to refinance your home loan.