Refinance Decision Maker – How to Decide to Refinance Your Current Mortgage
If you are shopping for a new home loan chances are you’re going to be sold on lower monthly payments, low rates, longer term, by your possible lenders. However, as the refinance decision maker you should do your own due diligence on whether or not this is something worth pursuing. Now you can do this subjectively or simply by saying that since the new one will require lower monthly payments then it’s okay.
It is advisable on to run the numbers and as the one who will make the choice, you should study these simple steps to objectively determine whether or not this is something that will pay off for you. The main idea is to compare the Net Present Value (NPV) of each refinancing plan. You get the closing costs and add the present value of future cash inflows coming from the savings that you’ll get. You can do this with Microsoft Excel or any standard spreadsheet program.
For each plan calculate the monthly or yearly payments (principal and interest included). Subtract your current plan’s monthly payment or yearly payment with the other options that you have. The consequence is the monthly or yearly savings.
Put up columns representing each year. It’s important that you compare terms that are equal in length of time with year 0 as the present time. Put the yearly payments you’ll have to make for each column (starting from year 1), one refinancing option per row. For example, for row 1 you’ll have Lender #1 and then the yearly payments in each of the columns. For year 0, put the closing costs and make sure it’s a negative number (representing outflow). Use the NPV function of Excel and select all the cash outflows (present) and inflows (future) and use a conservative rate such as 4% to 5% which is something you can get easily just by investing in CDs.
The higher the NPV, the better as this represents the value of future savings in today’s time taking already into account the net effect of closing costs.