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When Should I Refinance?

At some point during the life of your mortgage, you will probably want to consider refinancing, or 're-doing' your loan. You may want to reduce your interest rate, lower your monthly payment, consolidate multiple loans, or obtain cash for a remodeling project or child's education. No matter the reason for refinancing, the main question in deciding when, or even whether, to refinance is how long it will take to recoup the costs.

Refinancing a mortgage is not free. Because you are essentially getting a new loan, you will be paying closing costs again. The lender will need a new appraisal of the house and a new credit report, among other things. In order to determine whether savings from a lower monthly payment will be able to offset these costs, you need to know how long you plan on staying in the home.

First, determine what your new monthly payment would be if you were to refinance. Subtract this amount from your current monthly payment to determine how much you will save each month. Divide the closing costs of refinancing by the monthly savings to find out the number of months it will take to recoup the closing costs.

Let's say your current interest rate is 6.25% and your monthly payment is $1477. If you were to refinance at 5.5% for a monthly payment of $1277, you would save $200 a month. If the closing costs are $3800, divide it by $200. That equals 19, which means it will take 19 months before the closing costs are paid off and you can start enjoying the $200 extra per month.

If you plan on selling the house before then, don't refinance. If you will be staying for at least as long as it takes to recoup the costs, you may want to consider refinancing. Generally speaking, two years is a good amount of time for recouping the costs.

Another aspect you need to check into is whether your mortgage has a prepayment penalty. Some lenders may waive the penalty if you refinance with them, but you'll need to know the specifics of the penalty.