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How To Easily Calculate Whether It Pays To Refinance
The first step is to take your expected payment out of the equation. Most of my clients initially think that the payment savings is how much they will save, but that is cash flow savings, not actual savings of less interest paid. The payment involves loan amounts and amortization periods (15 or 30 years, for example) and anytime these factors change, the payment is going to change, regardless of the rate change. A better way to calculate your potential savings is how much INTEREST will be saved by a change in rate. This is very straightforward and I think an example will help: Let’s assume the loan amount (payoff) is $500,000, and the current rate is 6%. Hypothetically, if you are dropping the rate to 5.25%, multiply the estimated loan payoff ($500,000) by the difference in the interest rates (in this case, 6.00% - 5.25% = .75%, or .0075 on a calculator). $500,000 x .0075 = 3,750 In other words, regardless of your new payment amount, you will be charged $3,750 LESS interest initially. Now take this figure and divide by 12 to arrive at a monthly savings of $312.50. We’re almost done! To arrive at your break-even, simply take the total cost related to the refinance and divide by the monthly savings of $312.50. Let’s assume the total cost related to a refinance is $4000. $4,000 divided by $312.50 = 12.8, or about 13 months to recover all costs related to the refinance. As long as you know you will own the property a minimum or 13 months in this example, you should recover your costs, and will save substantially greater amounts the longer you keep the mortgage once passing your break-even point. For example, if you own the home for just 5 years, that’s 60 months. Take 60, subtract the number of months it took to recover your costs (13) and then multiply by your estimated monthly savings of $312.50. (60-13 -47, then 47 x $312.50 = $14,687 total net savings after 5 years, even taking into consideration the costs involved. Do you still believe it doesn’t pay to refinance unless you can drop the rate a full point as some would have you believe? As a general rule, the larger your loan amount, the smaller the interest rate change has to be in order for the savings to make a refinance worthwhile. One final point-this is an estimate of interest saved and is used as a quick guide. As the loan balance decreases over time, the monthly savings of $312.50 in this example will go down each month, but very, very slowly and not enough to dramatically impact the break-even calculations. I hope you find this article helpful! Article Directory: http://www.articledashboard.com |
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