When refinancing your mortgage you need to first decide what your goal is:
- Are you trying to improve your monthly cash flow?
- Are you hoping to pay off your loan at a certain date?
- Do you want to shorten the remaining term of the loan in order to save money in the long haul?
After you determine the goal of your refinance, deciding whether that goal makes sense (or not, given your personal situation) depends on a combination of factors:
- The differential between your existing interest rate versus the new rate in consideration
- How far along you are in your existing mortgage
- How long you plan on remaining in the new mortgage
- How much it will cost you to get the new mortgage
Improving cash flow
But it’s your goal that should dictate how you approach your refinance transaction. For example, cash flow improvement is usually best achieved with both a lower interest rate AND a re-lengthening of the remaining term to 30 years. However, if you don't plan on being in your home for the long run, you might look beyond fixed-rate mortgages to find even lower rates on adjustable-rate mortgages with shorter fixed-rate periods (i.e. seven years). Learn more by reading "Refinance into an adjustable rate mortgage."
Saving money long term
If you hope to save money in the long haul, re-starting the amortization clock (re-lengthening the loan) all over again won't work. Here’s why: If you are seven years into a 30-year loan, it will be really difficult to actually save money with a new 30-year term -- you would need a huge difference in interest rate to overcome the costs of another seven years of monthly payments. Better you should look to a shorter-term loan, such as 20-year, which would likely bring some break in rate (but not so much in payment, if any) while chopping three years off your remaining term, which creates tremendous savings.
Consider the cost
Then there are the costs of refinancing. If you pay them in cash, out-of-pocket, you'll need to be in the new mortgage long enough to not only recoup what you spent but also to get some actual savings. If it costs you, say $4,000 to refinance your loan, and the break in monthly payment is $100, it will take some 40 months (3.3 year) just to get your money back... and your savings won't start until then. If you stay in the mortgage for only four years, you'll end up saving only about $800 over that time, so it may not be worth the hassle.
You can pay costs by burying them in the loan amount (called a "low-cash-out refinance") or trading them off for a slightly higher interest rate; this can make your savings start as soon as your refinance is closed, but the difference in monthly payment from old loan to new will be smaller.
In short, it all depends on your situation. HSH.com has a great refinance calculator that can help you run though the various choices and scenarios to see which works best for you.
- Refinance on the dips
Mortgage rates fluctuate like waves in the ocean; refinancers who are chasing the lowest rates can lock in their loan when rates dip.