When is it Best to Refinance?
UNDERSTANDING POINTS AND INTEREST RATES
Points vs. Rates
Lenders cover their risk and make profit in two ways through the loan's interest rate and upfront fees called "points." When it comes to refinancing, the decision is based on how much money you will save by paying now or later. Typically, this has to do with how long you plan to have the loan.
Example Situation:
There is an existing loan balance of $300,000 at 6%. A Lender offers 5.5% with 2 points—or a 5.75% rate with no points. Which option is better? How do you evaluate both?
Evaluation
A point is equal to 1% of the loan amount. So the lower 5.5% rate will save you almost $1,150 per year, but cost you $6,000 in up front points.
Refinancing at 5.75% only saves $575 annually, but you are immediately ahead the $6,000 you didn't pay in points.
In this example, if you're planning on staying in the house for five or more years, the lower rate with points will put you ahead.
Note: If you replace a loan with 25 years remaining with a new 30-year mortgage, there will be an extra five years of payments. So you may want to ask your lender for a loan term that matches the remaining life of the original mortgage.
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