How do I Determine If Refinancing a Mortgage Will Save Money?

When interest rates fall, "refinancing" often becomes synonymous with saving money because you can get a lower monthly payment on your home mortgage. But, even if you can save on the monthly payments, refinancing your mortgage won't always save you money, especially if you know you're going to be moving soon.

Closing Costs

Refinancing isn't free. In fact, according to a 2012 Bankrate.com survey, closing costs on a $200,000 home average from just more than $3,000 in Missouri to more than $4,600 in Texas and $5,400 in New York. Unless you have that extra cash sitting around, you might have to roll the closing costs into the refinancing, which will increase your monthly payment because you're borrowing more. Plus, that's money you can use for other things, like paying off high-interest credit card debt.

Monthly Savings

Once you've figured out how much you need to refinance, you can figure out how much you're going to save each month by asking for quotes from lenders. If you can't get a lower interest rate, you're not going to save money. But you could get a lower interest rate if market rates have gone down or if your credit score has gone up. For example, if the market interest rate has gone down slightly, but you've gone five years without a missed payment and have paid down some of your large debts, you could get offers for significantly lower interest rates on your refinance.

Break-Even Point

Like most financial decisions, figuring whether the monthly savings for your refinance are worth the closing costs involves some calculation. To figure how long you need to keep the refinance to make it worthwhile, divide your closing costs by your monthly savings. For example, if your refinance saves you $90 a month and it costs $3,330, divide $3,330 by $90 per month to find you need to keep the refinance for 37 months -- more than three years -- before you break even. If you leave before then, you lose money on the refinance.

Tax Deduction Concerns

Don't fear that if you refinance you're going to lose your mortgage interest deduction because it's no longer an original loan. The IRS treats refinanced debt as home-acquisition debt, so you'll still be able to deduct the interest on the amount of your existing mortgage. For example, if you still owe $250,000 on your original mortgage and you refinance for $250,000, the entire refinance is still deductible. Plus, if you pay discount points on the refinance, you can usually deduct them over the life of the refinance.

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