Refinancing your mortgage to save $200 a month might seem like an easy decision, but it’s important to weigh the costs and benefits. In this article, we'll explore whether refinancing for this amount of monthly savings is truly worth it, and what factors you should consider before making a move.
Understand the costs of refinancing
Closing Costs
When you refinance your mortgage, you’ll encounter closing costs similar to those you paid when you first bought your home. These costs can include underwriting and broker fees, appraisal fees, and title insurance, and other expenses that typically cost 2% of the loan amount. It’s crucial to factor these costs into your decision, as they can significantly impact your overall savings.
Breakeven Point
The breakeven point is the time it takes for the savings from your lower monthly payment to cover the cost of refinancing. For example, if you spend $6,000 on closing costs to save $200 a month, it will take 30 months, or 2.5 years, to break even. Only after this point will you start to see real savings.
Interest Rates and Loan Terms
The new interest rate you secure through refinancing plays a critical role in determining whether the move is worthwhile. Even a small difference in interest rates can translate to significant savings over time. Additionally, consider whether you’re extending or shortening your loan term, as this will affect your total interest paid.
Why saving $200 a month is worth It
Long-Term Homeownership
If you plan to stay in your home for many years, saving $200 a month can add up to substantial savings over the life of the loan. For example, over 30 years, this could amount to $72,000 in savings, assuming you refinance into a new 30-year loan.
Current Interest Rate Trends vs. New Rate
If current mortgage rate trends are stable and significantly below your rate then refinancing savings are worth it. For instance, if you can lower your interest rate by 1% or more, the $200 monthly savings might be just the beginning of your financial benefits.
Improved Cash Flow
Reducing your monthly mortgage payment by $200 can improve your cash flow, giving you more financial flexibility. This extra cash could be used to pay down other debts, invest, or build an emergency fund, all of which contribute to a stronger financial future.
When to wait for a refinance saving $200 a month
High Closing Costs
If the closing costs for refinancing are high, they can offset the benefits of saving $200 a month. For example, if you spend $10,000 in closing costs, it would take 50 months, or over four years, to break even. If rates continue falling for 4yrs, it might be better to wait to reduce your breakeven under 2yrs.
Short-Term Plans
If you’re planning to sell your home or move within a few years, refinancing for small monthly savings might not make sense. You may never reach the breakeven point, meaning you could end up losing money in the long run.
Extending the Loan Term
While refinancing can lower your monthly payment, it often extends your loan term. If you’re 10 years into a 30-year mortgage and refinance into a new 30-year loan, you’re adding 10 more years of payments. This could mean paying more in interest over the life of the loan, even with a lower monthly payment.
Calculating the Breakeven Point
Breakeven Formula
To calculate your breakeven point, divide your total refinancing costs by your monthly savings. For example, if refinancing costs $6,000 and you save $200 a month, your breakeven point is 30 months, or 2.5 years. This calculation helps you determine if the refinancing is financially beneficial based on how long you plan to stay in your home. You should aim for a less than 2yr breakeven
Alternative Options to Consider
Make extra payments
Instead of refinancing, consider making extra payments on your mortgage. This can reduce your principal balance faster, leading to interest savings without the costs of refinancing.
Recast your mortgage
If you are able to make a $10K+ bulk extra payment, ask your lender to "recast" or recalculate the mortgage payment at the lower principal balance. This option allows you to adjust your loan terms without the costs associated with refinancing.
Customize your loan term
Before refinancing, consider a lower loan term to not restart your mortgage. If you are 10yrs into a mortgage, choose a custom 20yr term mortgage when you refinance, and you'll also enjoy and extra 0.25% rate reduction vs rates on current 30yr mortgages.
Common myths about refinancing
Myth 1: "Refinancing is always worth it if you save money."
Refinancing isn’t always the best option, even if it reduces your monthly payment. The associated costs and long-term impact on your loan should be carefully considered.
Myth 2: "Small savings don’t add up."
Over time, savings can accumulate into significant amounts, especially if you plan to stay in your home for many years.
Myth 3: "You should only refinance if you can save a significant amount."
Even modest savings, like $200 a month, can be worthwhile depending on your financial goals and the overall cost of refinancing.
Conclusion
Deciding whether to refinance your mortgage to save $200 a month depends on several factors, including your breakeven point, current loan balance, how long you plan to stay in your home, and your overall financial goals. By carefully weighing the costs and benefits, you can make an informed decision that supports your long-term financial health.
