Refinancing 101

Refinancing is simply the process of trading an old mortgage in for a new first mortgage at a lower interest rate in order to save on monthly costs. The trade-off, of course, if the fact that the new mortgage costs money to setup and may be extended over a longer period of time. The key to determining if one of these is right for you is to figure out your breakeven point.

Refinancing can help you save money as long as the total costs net of offsets are lower on the new mortgage than on the existing one. The costs typically include: origination costs, monthly payments of principal and interest, and lost interest. Cost offsets on both mortgages are cost savings and reduction of the loan balance. If the interest rate on the new mortgage is lower and there are other costs, the new mortgage will save you money.

Many borrowers who choose to refinance today choose to finance the upfront costs to do the refinancing itself. That is, they add the costs to the mortgage rather than pay them in cash. Usually, this reduces the gains from refinancing because the borrower must pay interest on the upfront costs at the mortgage rate, so it is important to pay in cash if at all possible. This lets you avoid paying interest on that money going forward.

In the end it is important to calculate your breakeven point when refinancing your mortgage to determine if it is worthwhile. It is also important to consider paying the refinancing costs themselves in cash or include those in your initial analysis to determine whether or not it is wise to do the refinancing at all. Regardless, refinancing can often save you money in the long run and can be an excellent source of cash!

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