Refinancing Guide
Refinancing Guide from Coventry Enterprises of America
Refinancing Guide
Should You Refinance?
Refinancing can be a smart financial move or an expensive mistake, depending entirely on the math and your specific situation. The financial industry has a strong incentive to encourage refinancing: every new loan generates new origination fees, regardless of whether the borrower benefits. Coventry Enterprises of America walks you through the honest analysis.
The break-even calculation is the foundation of any refinance analysis. Here is how it works: add up all your closing costs for the new loan. Then calculate how much you will save each month from the lower rate or shorter term. Divide total costs by monthly savings. The result is the number of months you need to stay in the loan to come out ahead.
Example: closing costs of $9,000 and monthly savings of $180 gives a break-even of 50 months, or just over four years. If you sell or refinance again before then, you lost money on the transaction. If you stay past four years, every month after that is net savings.
A rate-and-term refinance replaces your existing mortgage with a new one at a better rate or shorter term, without changing the loan balance substantially. The goal is to reduce your interest rate, lower your monthly payment, pay the loan off faster, or some combination of those three.
A cash-out refinance replaces your mortgage with a larger loan and pays you the difference in cash. Homeowners use it to fund home improvements, consolidate debt, or cover large expenses. The risk is that you are increasing your mortgage balance and resetting your loan term. If you cash out $50,000 and roll it into a new 30-year mortgage, you have extended your payoff date and added to your principal. At today's rates, that cash costs real money.
Resetting to a 30-year term when you have already paid down several years of your mortgage extends your debt burden unnecessarily. A homeowner seven years into a 30-year mortgage who refinances into a new 30-year loan effectively turns their 23 remaining years into 30, adding seven years of payments even if the rate drops.
Ignoring closing costs is perhaps the most common mistake. Borrowers focus on the monthly payment difference and forget to account for the $8,000 to $15,000 in costs to get the new loan. If you plan to sell within two years, those costs likely outweigh any monthly savings.
Refinancing out of an FHA loan into another FHA loan without removing mortgage insurance means you continue paying MIP even if your equity has grown past the point where a conventional loan would eliminate PMI. If you now have 20 percent equity, refinancing into a conventional loan and eliminating the insurance premium might save more than the rate reduction alone.
Chasing small rate differences with large fees is another trap. A 0.125 percent rate drop on a $300,000 loan saves about $25 per month before tax effects. If the closing costs are $8,000, the break-even is more than 26 years. It rarely makes sense.