The Arithmetic of Refinancing

By Broderick Perkins

Most home owners refinance to save money month-to-month, but unless you do the math before you trade in one home loan for another you could be wasting both time and money.

What you truly save is based on how much the new loan costs and how long you'll be in the home.

Here's what you've got to consider:

Costs: Add up ALL the costs, which could include points, and fees for the application, loan origination, appraisal, attorney, credit report, extra insurance, inspections, private mortgage insurance, recording, survey, title insurance, underwriting and others.

Monthly Savings: Figure your monthly savings by subtracting your current monthly payment from your refinanced mortgage's monthly payment.

Tax Cost: Multiply your monthly savings by your combined state and federal tax rate.

Net Savings: Subtract your tax cost (because the cheaper loan gives you a smaller tax benefit than the previous loan) from your monthly savings.

Break-Even Point: Divide your total costs by your net savings to determine how many months it will take to pay off the cost of refinancing.

For example, if you will save $100 a month on the refinanced mortgage and the refinanced mortgage costs you $2,500 it would take you just over two years, 25 months, to break even and start enjoying that savings.

If you plan to move within two years, that loan might not be for you.

Hidden costs: Also, if your current loan contract includes a prepayment penalty you've got to factor it in too. Some penalties can be as high as six months interest on 80 percent of your balance, but diminish the longer you hold the loan.

The points vs. interest rate also presents a mathematical quandary and, but again, do the math.

Generally, lower points (each point is 1 percent of the amount financed) produce a higher interest rate. Higher interest rates mean lower points.

If you know you'll stay in your home for a few years, a zero-point loan option would likely be a better deal because you may not have the opportunity to recoup those costs. If you are staying longer with more time to recoup costs, consider a cheaper interest rate with points.

Watch out for some no-pointers. They can be useful if you are cash poor, but in addition to the higher interest rate, some come with prepayment penalties that kick in if you refinance again too soon.

To obtain bottom-line precision on calculating your savings, especially when you shorten the term, you need loan-amortization schedules available on Web-based mortgage calculators or a patient mortgage broker or lender who'll churn out all the numbers.

To find the best deal, start with your current mortgage lender. Some lenders have marketing programs designed to retain current borrowers by offering them special low-rate, low- or no-cost refinance packages.

Even if your current lender makes a deal you like, use that loan as a benchmark and shop around for your best deal. To get shopping around help, consider references from family members, co-workers, real estate agents and other people you trust, especially those who've recently refinanced.