|
Three Rules of Thumb for Mortgage
Refinancing
by: Stephen L. Nelson, CPA
You
might think that deciding to refinance a mortgage requires
only a quick comparison of loan interest rates. Unfortunately,
that’s not really true. Refinancing is trickier than that!
Fortunately, three useful rules of thumb can often help you
make sense of refinancing opportunities.
Rule 1: Don’t Ignore Total Interest Costs
You really want to use refinancing as a way to reduce the
total interest cost you pay. While that sounds simple in
principle, it is sometimes difficult to do. The interest costs
you pay are a function of the interest rate, the loan balance,
and the loan term period.
When
people refinance, they tend to focus solely on the loan
interest rate. But they often don’t pay as much attention to
the loan term or the loan balance.
When
you use refinancing—even refinancing at a lower interest
rate—to increase your borrowing or to extend the time over
which you borrow, you often aren’t saving money.
Rule
2: Trade Expensive Money for Cheap Money
For
refinancing to make economic sense, however, you do need to
swap higher interest rate debt for lower interest rate debt.
This calculation, however, is tricky. To make an
apples-to-apples comparison, you must look at the annual
percentage rate that will be charged on your new loan—this is
the best measure of the new loan’s interest rate cost—and then
compare this to the loan interest rate on your old loan.
You
don’t want to compare interest rates on the two loans nor do
you want to compare annual percentage rates on the two loans.
Again, just to make this perfectly clear: You want to compare
the loan interest rate on the old loan to the annual
percentage rate on the new loan.
When
the annual percentage rate on the new loan is lower than the
loan interest rate on the old loan, then you are truly paying
a lower interest rate.
Comparing annual percentage rates with loan interest rates
seems confusing at first. But note that you would pay only
interest on your old or current loan, so that’s all you need
to look at in terms of its costs. With a new loan, however,
you would pay both interest and any origination or closing
cost fees. The annual percentage rate wraps the interest rate
charges and setup charges, origination charges, and closing
cost fees into one interest rate-like number.
Rule
3: Don’t Lengthen the Repayment Period
Be
careful that you don’t extend the length of time you borrow by
continually refinancing. For example, one common rule of thumb
states that every time interest rates drop by two percentage
points, you should refinance your mortgage. However, there
have been times in recent history when following this rule
would have had you refinancing your mortgage every few years.
This could mean that you would never get your mortgage paid
off. If you refinanced every few years, you would suddenly
find yourself still 30 years away from having your mortgage
paid.
Read more: Click Here!
.............................................................................................................................
|
.......................................................................