RUN THE NUMBERS When You Should Refinance Your Mortgage It is sometimes advantageous to refinance an existing mortgage when interest rates decline. In mortgage refinancing, a new mortgage is obtained to pay off and replace an existing mortgage. Most often it is undertaken to lower the monthly payment on the home by taking out a new loan with a lower interest rate. The example here illustrates how to determine whether refinancing your mortgage is a wise choice. The original mortgage for $160,000 was obtained seven years ago at a 5.5 percent interest rate for 30 years. The monthly pay- ment is $908. After seven years, the principal owed has declined to $142,100. If interest rates for new mortgages have declined to 4.5 percent, the owner could take out a new mortgage at the lower rate for a monthly payment of $827. Borrowing $142,100 for 23 years at 4.5 percent saves approximately $81 per month ($908 - $827). How- ever, refinancing may have some up-front costs, including a possible prepayment penalty on the old mort- gage and closing costs for the new mortgage. The question then becomes, will these costs exceed the monthly savings gained with a lower payment? DO IT IN CLASS The following worksheet provides a means for estimat- ing whether refinancing offers an advantage. It compares the future value of the reduced monthly payments (line 5) with the future value of the money used to pay the up-front costs (estimated here at 2%) of refinancing (line 8). The homeowner would need to estimate the number of months he or she ex- pects to own the home after refinancing. Given an estimate of four years in this example, the net savings would be $977 (sub- tracting line 8 from line 5), and refinancing would benefit the owner. In this example, planning to live in the home only three more years would result in it not being financially advantageous to refinance. A similar worksheet can be found at www .bankrate.com/calculators/mortgages/refinance-calculator.aspx. Example $908 Your Figures Decision Factors 1. Current monthly payment 2. New monthly payment 3. Monthly savings (line 1 - line 2) 4. Additional years you expect to live in the house 5. Future value of an account balance after 4 years if the monthly savings were invested at 3% after taxes (using the calculator on the Garman/Forgue companion website) 6. Prepayment penalty on current loan (0%) 7. Points and fees for new loan (2%) 8. Future value of an account balance after 4 years if the prepayment penalty and closing costs ($4,263) had been invested instead at 3% after taxes (using the calculator on the Garman/Forgue companion website) 9. Net saving after 48 months (line 5 - line 8) It may also be possible to borrow more than the current balance owed on the existing loan, thereby utilizing some of the equity built up in the home. Borrowers refinancing for more than the amount owed should understand that 827 81 4 4,175 0 2,842 3,198 $977 rebuilding the equity to its previous level may take many years. This also is dangerous because if home prices decline the borrower will owe more on the home than it is worth.