Should I refinance is the question I often hear from individuals. In this article we give you guidance and a calculator to help answer that question. This article is written from the stand point of refinancing one loan with a similar type of loan. Specifically, one fixed loan to another fixed loan. Other types of refinancing (i.e. from variable to fixed, interest only to principal and interest, etc...) are more complicated topics which we take up in another article.
Should I Refinance a.k.a. Is it Worth My Time?
The simple answer is this. If its going to save you money....YES. For student loans this almost always applies. It does not apply if you have to pay fees with the refinancing of your student loan which is a more complicated case. Fees are almost always present when refinancing mortgages so that is what we will discuss in this article.
The decision is ultimately based on how much value you place on the savings versus the time it takes to refinance. There are two ways of looking at this question. What I call the "Pure Finance" way and the "Break-Even Analysis" way. In this article we dive into the Pure Finance way.
The Pure Finance Way Of Answering Should I Refinance
From a pure finance perspective, you should always refinance if it saves you money over the life of the loan. In this analysis you need a few numbers. You need your existing loan details, the loan details you are thinking about refinancing into, and the costs of the refinance. Using the calculator to the right titled Mortgage Payment Calculator, enter your current loan details.
For our example, we assume the loan is $400,000, 25 years remaining, and an interest rate of 5.0%. The resulting monthly payment is $2,338.36. Next, using the "simple calculator" to the right determine the cumulative payments by taking the monthly payment of $2,338.36 and multiplying in first by 12 (for months in a year) then multiplying that answer by 25 (the remaining years left in the loan). The result is $701,508.00.
Next enter the loan you are thinking about refinancing into. In this case we will use the same loan amount, 30 year term, and an interest rate of 4.25%. The resulting monthly payment is $1,967.76. The cumulative payments (using the calculation described above but replace 25 with 30 to represent 30 years remaining) are $708,393.60
In this situation the cumulative payment is less for your current loan than refinancing. In this case you would choose not to refinance. If the refinance loan calculation results in a lower payment then you must add one more step. You take the overall savings then subtract the cost of the loan. If the resulting number is positive, then you should refinance. If not, then keep your original loan.
There are many caveats that occur to each persons situation. Please seek help from a financial professional before making your decision. If this article helped you, it most likely can help someone you know. Please make sure to share. Stay tuned for part 2.....