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How to decide whether to refinance

By Holden Lewis · Bankrate.com
Thursday, May 27, 2010
Posted: 10 am ET

Should I refinance? That's the question on the minds of readers, via e-mails and blog comments. I can't answer each question, but I can tell you how to decide for yourself. The tools you need are available on Bankrate.

I'll step you through a simple rate-and-term refinance. In reality, there are few "simple" refi scenarios nowadays. This is a hypothetical situation to show how to tackle the should-I-refi question.

In this hypothetical, let's say you bought a house in spring 2004 and paid a discount point or two to get the rate down to 5.25 percent. You borrowed $200,000, you've been paying faithfully ever since, and today you have at least 20 percent equity. Again, I acknowledge that this is a fairy-tale situation sprinkled with pixie dust, but I want to keep it simple.

Using Bankrate's mortgage amortization calculator, I plug in the numbers and see that this loan, beginning in March 2004, has monthly principal and interest of $1,104. I click "Show/recalculate amortization table" and see that the current loan balance (i.e., as of May 2010) is $180,005.

Let's say you have the cash to pay all the mortgage fees and you're able to get the following rates today on a loan of $180,000:

  • A 30-year fixed at 4.875 percent.
  • A 15-year fixed at 4.25 percent.

Plug the numbers into the mortgage calculator. The monthly principal and interest on a 30-year mortgage totals $953. But that means starting over with a 30-year loan, when your original loan had 24 years left on it.

So change the mortgage term. In the second window, which reads, by default, "30.000," type "24" and recalculate. The monthly principal and interest would be $1,061 -- a savings of $43 a month over the current monthly payment.

A 15-year loan at 4.25 percent yields a monthly principal and interest payment of $1,354. Plug the numbers into the calculator and you'll see.

Let's look at the total principal and interest payments over the full term of each loan. Call the 30-year loan, with monthly principal and interest of $953, Scenario 1. The 24-year loan, with P&I of $1,061, is Scenario 2. The 15-year loan, with P&I of $1,354, is Scenario 3.

  • Total principal and interest of Scenario 1: $953 X 12 months X 30 years = $343,080.
  • Scenario 2: $1,061 X 12 months X 24 years = $305,568.
  • Scenario 3: $1,354 X 12 months X 15 years = $243,720.

To decide whether to refinance, you need to run the numbers in a similar fashion. After that, it's a matter of personal judgment -- whether a refi is worth the fees, whether it's better to trade off higher monthly payments for less total interest, or whether you'd rather have lower monthly payments but pay more interest over time. You might choose that last option if you have a kid in college and you need as much monthly cash as possible.

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