A mortgage is a financial obligation; it is not merely a monthly installment. It can add assets to your personal balance sheet and at the same time increases your liabilities. The net worth of a property always depends upon the mortgage behind it. Refinancing a mortgage may decrease your monthly installments, but it will also decrease the value of your asset. Without proper calculation a refinancing will end you in paying more for the same property.
When will the real savings begin? Calculating the pay back period is a simple method followed to check the profitability of a refinance. To do this we require three inputs, 1) The cost of refinancing, 2) the monthly installment for the present finance and 3) the monthly installment after refinancing. Naturally the third will be lesser than the second, find the difference. It is your monthly savings after refinancing. Divide the total cost of refinancing with the monthly savings of after refinance. The number of months we got is the payback period. You will be able to experience the real benefit of refinancing only after that period. So it is always better to have small payback period.
Understand the real cost of refinancing:
By comparing the payment charts of the two finances you can understand the real cost of refinance. Take the remaining schedule of the present mortgage and try to compare it with the schedule of the potential new one. The costs of refinancing are added in the principal of the new mortgage. If you bear them from your pocket, then you should deduct the same amount from the principal balance of the present finance. We will do this because, if we have enough savings to pay the costs of refinance, you can pay them for present loan and then they will be deducted from the principal which decrease your monthly interests. Why can not you consider that? (This is only the first question raised by comparison)
In the second step, we deduct the assumed monthly savings after refinance from the principal balance of the new amortization schedule. At least in theory we should use our savings to repay our debts, is not it? After doing this let us once again come to comparison. At some point of time, the principal balance of the new finance will be less than the existing one. And this period of time is the real pay back period which we discussed earlier. Only after this period the net worth of your asset will increase due to refinance.
Do not confuse about the amortization charts, you can find them in internet or you can generate them in a little time with the help your banker. Do not think that all these calculations are headache. They are just simple interest along with some additions and subtractions. By paying attention to these figures you will understand your finances better by which you can avoid bigger troubles and save your self few thousand of dollars. Learning always pays, is not it?
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