Will Refinancing Your Mortgage Save You Money?
Refinancing a mortgage is simply taking out a new mortgage
to pay off the present loan on a home. People refinance loans
for many different reasons.
- The most common reason is to save
money. If you can get a loan with a
lower interest rate, your monthly mortgage payment and the
total amount of interest you pay will be less.
- You can also save money by reducing the number of years
of your loan. For example, you may decide to change from
a 30-year to
a 15-year mortgage. Depending on the interest rate, your
monthly payment may stay the same, or even increase.
However, the total amount of interest you pay will be less.
- Depending on interest rates, you may want to change from
an ARM (Adjustable Rate Mortgage) to a fixed-rate mortgage.
With a fixed-rate mortgage, you know your mortgage payment
will be the same amount each month.
- Changing from one ARM to another ARM with a lower interest
rate can save you money. Another reason to change ARMs is
to get better protective features such as payment caps.
A payment cap limits the number of times interest rates
can be raised or the length of time between interest rate
- You may want to refinance to get money for other family
expenses. For instance, you can use the equity or cash value
in your home for a major expense such as a childs
education or a remodeling project. You may want to refinance
to consolidate debts or pay off high interest loans. Instead
of these loan payments, you would have a larger mortgage
but at a lower interest rate and the interest paid would
be tax-deductible. However, be cautious about continuing
to use your credit cards if you refinance because of potential
You need to find out how much refinancing costs. First, check
to see if your present mortgage has any kind of prepayment
penalty. Next, compare interest rates and loan types for at
least three lending institutions. Find out what kinds of fees
or closing costs are charged for a new mortgage. Fees for
the appraisal, loan application, title search, title insurance,
home inspection, and legal advice are common costs. Loan origination
fees (also called points) are the largest closing cost you
will pay. A point is usually one percent of the total loan.
One point or one percent of a $90,000 loan would be $900.
See Table 7: Comparison
of Refinancing Costs
Under current tax law, the points charged when refinancing
arent all deductible from federal income tax in
one year. The costs must be amortized over the life
of the loan. To do this you must divide the amount of
the points by the number of years of the loan. For example,
if you have $900 in points for a 10-year loan then you
may deduct $90 per year from your taxes ($900 divided
by 10 years equals $90).
On an original mortgage the total cost of financing
points is usually deducted in the year its paid.
An additional tax consideration is if the mortgage payment
de-creases with a refinanced mortgage then therell
not be as much yearly interest to deduct.
Figuring Out If Refinancing Saves Money
One of the important things to look at is how long you plan
to live in the home. If youre refinancing to lower the
monthly payments, do the following calculation to find out
the time it will take until you meet the break-even point
and start saving money. This analysis works if youre
refinancing to save money on monthly payments or when refinancing
a fixed-rate mortgage with a lower fixed-rate.
- Calculate the total refinancing cost. Example: $2000.
- Calculate how much youll save each month on payments.
Example: $50 each month.
- Divide the total refinancing cost by the monthly savings
to get the number of months you need to keep your home to
Example: $2000 divided by $50 equals 40 months. In this
case, you should consider refinancing only if you plan to
live in the home for at least 40 months.
Refinancing costs divided by savings per month on
mortage payment equals number of months break even.
If youre refinancing to switch from an ARM to a fixed-rate
loan, or from a 30-year loan to a 15-year loan, its
much more difficult to perform a break-even analysis. However,
on the Internet there are financial calculators that can help
you. For example, Fannie Mae has several useful calculators
Zero-Point/Zero-Fee Mortgage Loans
Some lending institutions offer loans without points. Sometimes
lenders even pay some of the other closing fees. You dont
need to do a break-even analysis if you have no refinancing
How can lenders afford to offer no-fee refinancing deals?
The financial institutions hope that youll live in your
same home for several years. Interest rates on zero-point
loans are a little higher, and the lender will recover costs
after several years have passed.
One disadvantage of zero-point mortgage loans is that youll
pay a higher interest rate and, over the years, more total
interest. On the other hand, zero-point/zero-fee loans are
good if you plan to sell your home in two or three years.
This is an attractive loan when you think interest rates will
continue to fall and you may refinance again in a few years.
Written by Barbara Cooper, former Consumer and Family Economics
Extension Educator, University of Illinois Extension.