The idea of paying less in total interest and owning your home sooner is appealing. But will refinancing to shorten your term impact your overall financial plans in a way that works for you?
Refinancing costs and fees have the potential to add up to 2% of the total new loan amount, so it’s important to ask yourself if the savings from the new loan will be equal to or more than the cost of refinancing. Consider the overall cost of refinancing, and your "break-even point" – when the closing costs related to the refinance are finally repaid by your monthly savings.
Factors that go into the cost of refinancing include:
- Loan origination and application fees
- Any penalty for early payment on your current mortgage
- Standard settlement charges including fees for credit reports, title searches and insurance fees, and appraisals
- Talk over tax implications: Consult your tax specialist for specific guidance on what effects changing your repayment period may have on your tax picture.
- Determine how much flexibility you need: Reducing your repayment period means putting more money into your property in the near future, which can mean less financial flexibility and cash flow. Get a good, clear grasp of what you need for everyday funds now (plus some extra) and make sure that’s covered before changing your repayment period.
- Assess your stability: You will need to come up with a larger payment each month. Are you fairly sure you’ll stay in your job or your neighborhood? Do you have enough to keep up payments in an emergency?
- Think about changes ahead: If you decide to move and sell your home, you may not realize the full amount of savings on interest costs. And if the market changes, your home may not function as an asset in your future financial plans.
- Compare other ways to save: While applying more money toward the principal may be one way to save over time, you might want to compare what would happen if you put the same amount of money toward a retirement savings plan or another savings instrument.
- Compare other ways to reduce debt: If your primary motivation is reducing debt, the typical advice is to pay off the most costly debt first. While a mortgage is a huge asset, its interest is typically lower than something like high-interest credit card debt. So be sure to ask yourself if it’s the most effective way to lessen your debt overall.