When’s the right time to refinance your mortgage?

That seems like a question with an obvious answer, right?  You refinance when the interest rate on the new loan is lower than your rate on the current loan.  But  how much lower?  And is it really as simple as subtracting one rate from another and signing on the dotted line?When I talk to mortgage brokers the question they typically ask is how long does the person considering a re-fi plan to keep his or her home.  Then, they calculate a break-even point based on the savings from the reduced payment compared with the cost of the re-fi..  For example, a client whose rate would go from 6% to 4.568% on a 30 year mortgage for $330,000 could reduce her payments $570 per month or $6,840 per year.  Compared these savings with the $2,500 in costs to get the new loan, and this person would break even in less than five months.

That’s how a mortgage broker thinks about a re-fi.  As a financial planner, I take a demand a more comprehensive analysis.

As a financial planner, I would want to know how the lower interest rate on their new loan — and the lower mortgage interest deduction — is going to change their tax situation.  I also want to know how long the borrower has held their current mortgage.

Why do I care about the age of the current mortgage?  When you pay interest and principal on a loan you do NOT do so in equal amounts.  Instead, you pay themore interest up front, and then you pay more and more principal as a percentage of the total payment each year you hold the loan.

This table shows how the balance between principal and interest payments changes over the life of the loan.

Year Principal Interest
1 12% 87%
5 17% 83%
10 25% 75%
15 35% 65%
20 49% 51%

Let’s go back to the example I discussed above. In this case, the clients have been paying on their loan for 13 years. So, they’re now in the period of the loan when between 25 and 35% of every loan payment goes to principal. .If they refinance, they have to start all over with only 12% of the payment going to principal.  They have a lower payment, yes, but they have also added years — and dollars — to the total cost of their loan.

[To add some numbers to this example, the total cost of their current loan will be $466,000, while the total cost of the new loan would be $617,000.  Which loan would you rather have?]

Of course, making this kind of decision is more complicated than comparing two numbers.  Do you need the extra cash flow from the refinanced mortgage?  Will you use this “extra money” to invest for your retirement, or to pay for college for your kids?  Is it important for you to pay off your mortgage before you retire? These are just some of the real-life questions I deal with every day.

As an hourly financial planner, I can’t make decisions for you, but I can provide you with my experience in these issues, and I can give you the numbers you need to quantify the long-term impact of your financial choices. That’s the best way I know for you to make the kind of informed decisions that will make life better for you and your family — right now, and well into the future.

If you’re uncertain about some of your financial choices, an independent, hourly financial planner can help answer your questions, provide you with strategies and come up with effective solutions.  My help is only a phone call away.