Refinancing can help you pay off your loan faster, get cash for home improvement, or lower your monthly payment. Let’s do some math to see if refinancing makes sense for you.
Evaluate Your Equity
What is equity? Equity is the dollar-amount difference between your home's value and the total amount you owe on your mortgage.
For example, if your current mortgage balance is $80,000 and your home value is $100,000, your equity is $20,000.
The amount of equity you have in your home factors into whether you qualify for a refinance mortgage and which options are available to you.
Calculating Loan-to-Value (LTV) Ratio
The loan-to-value (LTV) ratio shows this same difference as a percentage. A mortgage with an 80% LTV means the mortgage is 80% of the property's value. If your LTV is higher than 80% you'll likely have to pay mortgage insurance (PMI). Mortgage insurance would be included in your monthly payment.
For example, if your current mortgage balance is $80,000 and your home value is $100,000, your LTV ratio calculation would be: $80,000 ÷ $100,000 = 0.8 (80%).
Based on that calculation, 80% of the home's price is borrowed and $20,000 is equity. You are not required to pay mortgage insurance and refinancing could save you money, but it is generally not advised to take out any equity. Cashing out equity would put you over 80% LTV and you would begin paying for PMI. It is also a smart practice to only cash out equity to invest back into your home for a remodel or to finance projects like a roof or furnace.
Find Your Break-Even Point
You may be saving on monthly payments by refinancing, but the process does come with some fees and closing costs. How long will it take for your monthly payment savings to equal your refinancing costs?
Calculate your break-even point by dividing your refinancing fees by the amount you'll save each month with your lower mortgage payment.
For example, if your refinance fees total $5,000 and a refinance mortgage will save you $200 a month, your calculation would be: $5,000 ÷ $200 = 25 months until you break even.
If you don't plan on staying in your house for that long, refinancing might not make sense in the long run.