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15 minutes can save you 15 percent or more on your mortgage

posted Apr 26, 2011, 5:40 PM by Massey Kouhssari   [ updated Apr 26, 2011, 6:13 PM ]

With interest rates at historic lows, homeowners across America are refinancing their home mortgage loans. By refinancing into a lower interest rate, they expect to save thousands of dollars over the life of their new mortgage loan. But how do you determine whether to refinance? How do you know if it is worth it to refinance? Refinancing can be complex, and a few minutes of careful planning could save you thousands on your refinance. Here are three key guidelines to follow when refinancing.

  1. Is your mortgage adjustable-rate (ARM) or fixed-rate? If you have an adjustable-rate mortgage, your lender can raise your rate on a regular basis over the life of your loan. There probably is a rate cap, but it may be very high. While rates are currently low you should convert to a fixed-rate mortgage as soon as possible.

  2. For how many years have you been paying your mortgage? With a typical 30-year mortgage, for the first ten years you are paying primarily interest. Then the balance begins to shift and you will pay proportionately more principal. At the end of your 30-year mortgage you will be paying mostly principal.

    Why does this matter? Because when you refinance, you are essentially taking out a new mortgage. If you have been paying your mortgage for fifteen years, you're halfway to the final payoff! If you refinance, you will be starting all over again, and paying mostly interest.

  3. There are five key elements that will affect whether or not it pays to refinance. These are: the term of the new mortgage (15-, 20-, or 30-year); the amount you need to borrow; the fees you will pay to refinance; the current interest rates; and your credit history.

All of these five elements mentioned in point 3 above are variable. Let's consider the term. If your goal is to reduce your monthly mortgage payments, then you may want to consider a 30-year mortgage, because the monthly payments will be lower than what you're paying now. If you are capable of making the same monthly payments as you are now and hope to pay off your mortgage sooner, then a shorter term, with correspondingly higher payments, may make sense.

For example, let's say you have a fixed-rate 30-year mortgage at 8% and your initial loan amount was $180,000. Your payments, not including taxes and fees, are $1,320 per month. You've been paying for six years, so you have 24 years left on your loan. You go online and see that you might be able to get refinanced at six percent. You need to borrow the principal amount left on your current mortgage, which is $165,000. Using one of the free online mortgage payment calculators, you plug in the numbers.

You see that you have choices.

  • If you stick with a 30-year loan, your monthly payments will be reduced to $989. The downside is that you will be paying for the next 30 years from today, not 26.
  • If you choose a 25-year loan, your payments will be $1,063 per month. This is still less than what you are paying now, but you will pay your mortgage for one year longer than you are now.
  • If you choose a 20-year loan, your payments will be $1,182 per month. This is slightly less than what you are paying now, and you've shaved four years off the term of your loan. But remember that in every case you need to add the refinancing fees, which are typically $2,500 or more.
What are your objectives? If you anticipate living in your home forever and are young enough to expect to complete the full mortgage term, then it makes sense to pay as much as you can and own your home as quickly as possible. But if you anticipate moving in the next few years, you need to consider the cost of refinancing and whether or not it will pay to refinance to lower your monthly mortgage payments.