Computing the net benefit of a refinance transaction may be a pretty tricky thing to do if you do not know what to compute. But here, we're gonna put our attention to the net benefit of the transaction from the standpoint of reducing your current interest rate. Although there could be many reasons for one person to refinance, the most popular one is to lower people's mortgage rate so as to save on the interest payments.
If your goal in refinancing is to save on the interest through a lower rate, then the savings should be computed with the calculation below:
1. (loan amount x interest rate) / 12 = your monthly interest payment
Example:
(200000 x .06) / 12 = $1K
Now that it is established that you are paying $1K a month for the interest, what should be computed next is your monthly interest payment with the refinance term. Let's say your new interest rate is 5%, then your new monthly payment will computed as follows:
(200000 x .05) / 12 = $834
If we compare the two term's interest payments, it appears that a $167 savings can be achieved in refinancing.
However, that shouldn't end in that. We should still compute the break even point so as to figure out how you benefit after the closing costs.
Computation:
(closing costs - escrows) / interest savings = number of months of break even
Example:
($6K - $1K) / $167 = 30 mos.
Meaning, it would take 30 mos. to retrieve the refinance cost. You can consider this deal if you want to keep the mortgage for that long.
Lastly, we should also compute your net benefit for refinancing:
(savings per month x months you'll keep the mortgage) - (closing costs - escrows) = savings net
That is,
($167 x 120 mos.) - $5K = $15k
So if you kept your mortgage for a period of 120 months, you would save apprx. $15K.
As a whole, calculating a refinancing's net benefits is pretty crucial as it would determine if taking this step is a strategic move for you. However, each mortgage may always differ from another so calculations adjustments may also be necessary.
