Let's assume, as we did in my previous analysis, that you are looking to refinance an existing 30 year mortgage with another 30 year mortgage, and you are not going to take out any cash at closing. In this situation, the main benefit of refinancing is that you are going to lower your monthly payments. However, there are two costs that offset this benefit:
- The closing cost associated with refinancing. This is usually paid up front when refinancing.
- The fact that equity is going to build up more slowly than it would have under the original mortgage.
The question is how much of effect does this have?
To examine this, let's assume again that your original mortgage is a 30 year loan for $300,000 at 6%. Now let's assume that you can refinance it with another 30 year loan at 4.5%. Finally, we will assume that the closing costs to refinance are $5000. Will we come out ahead by refinancing?
I ran the numbers two ways. First, I looked at the scenario where you are refinancing your original mortgage after making payments on it for 5 years. Then, I looked at the scenario where you are refinancing after 10 years. If you remember from the previous article. If you refinanced after 5 years and held onto your house for the life of the mortgage, you would come out ahead by refinancing. However, if you refinanced after 10 years and held onto your house, you would come out way behind. The question becomes how far ahead or behind would you be if you sold your house before the mortgage was paid off.
The graph below shows how far ahead/behind you would be under both scenarios if you sold after N years:
|Refinance Analysis. Source: http://www.moneybythenumbers.com/|