Refinancing often seems like a great way to reduce your monthly mortgage payments and leave you with more money for other things. However, when you’re weighing the pros and cons of a refinance, don’t forget to consider how this move can affect your 澳洲幸运5官方开奖结果体彩网:net worth.

Why? A mortgage is more than a monthly payment. It is a 澳洲幸运5官方开奖结果体彩网:debt instrument used to finance an asset. And that accounting-professor jargon means t൲hat having a mortgage lowဣers your net worth.

Here’s how the reasoning works. On a household’s balance sheet, a mortgage is a liability. As such, it is subtracted from the household’s assets to determine its net worth. Too many consumers fall into the trap of 澳洲幸运5官方开奖结果体彩网:refinancing a mortgage in order to lower their monthly payments without considering how that refinancing affects their total net worth. Does refinancing your home ever pay off? Or is it just a short-term fix to a bigge🌄r problem?

The Payback Period Method

The most popular method for determining the economics of mortgage refinancing involves calculating a simple payback period. This eqꦦuation is made by calculating the sum of the monthly payment savings that can be realized by refinancing into a new mortgage at a lower interest rate and determining the month in which that cumulative sum of monthly payment savings is greater than the costs of refinancing.

Suppose, for example, you have a 30-year 澳洲幸运5官方开奖结果体彩网:fixed-rate mortgage loan for $200,000. When you took it out, you got a 6.5% fixed interest rate, and youᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚr beginning-of-the-month payment is $1,264. If fixed interest rates now are at 5.5%, this could reduce your monthly payment to $1,136, m🔥aking for a monthly savings of $128, which is $1,536 annually. The typical rule of thumb is that if you can reduce your current interest rate by 0.75% to 1% or higher, it could make sense to consider refinancing.

Using a 澳洲幸运5官方开奖结果体彩网:mortgage calculator is a good resource to compare these costs.

Next, you’ll need to ask 澳洲幸运5官方开奖结果体彩网:your new lender to calculate your total closing costs for the possible refinance. For example, if they come to $2,300, your payback period would be 1.5 years in the home ($2,300 divided by $1,524). Thus, if you plan on staying in the home for two years or longer, refinancing makes sense, at least a𝓰ccording to the simple payback period method.

What the Payback Period Method Misses

However, this method ignores th🅺e hous🌌ehold’s balance sheet and the total net worth equation. Two primary things are unaccounted for.

Cost of Refinancing

With the simple payback period method, the 澳洲幸运5官方开奖结果体彩网:principal balance of the existing mortgage versus the new mortgage is ignored. However, refinancing is not free. The costs of refinancing must be paid out of pocket or, in most cases, rolled into t✤he new mortgage’s principal b𒅌alance.

When a mortgage balance increases through a refinance transaction, the liability side of the household balance sheet increases, and, all other things being constant, the household net worth immediately decreases by an amount equal to the c𒁏ost of refinancing.

Total Mortgage Interest Paid

Just b✅ecause you are getting a lower interest rate on your r🐟efinanced mortgage doesn’t mean that you will pay less in total interest on it. For example, refinancing a 30-year mortgage with 25 years left until it is paid off into a new 30-year mortgage means that you might end up paying more total interest over the life of the new mortgage. It all depends on how much lower the new interest rate is.

The Household Net Worth Method

A more financially sound way to determine the economics of refinancing that incorporates the actual costs into the household net worth equation is to compare the remaining 澳洲幸运5官方开奖结果体彩网:amortization schedule of the existing mortgage against♛ the amortization schedule of the new mortgage.

The amortization schedule of the new mortgage will include the costs of refinancing in the principal balance. If the costs of refinancing will be paid out of pocket, then for a proper comparison, t🌠he same dollar amount should be subtracted from the existing mortgage’s principal balance. This is based on the assumption that if the refinance transaction does not take place, the money you would shell out for costs could instead be used to pay down the principal balance of the existing l🦹oan.

Subtract the monthly paܫyment savings between the two mortgages from the new mortgage’s principal balance. This is done because, in theory, you could use the monthly savings generated from refinancing to reduce the principal balance of the new mortgage. T✅he month in which the modified principal balance of the new mortgage is less than the principal balance of the existing mortgage is the month in which a genuinely economical refinancing payback period, one based on household net worth, has been reached.

By the way, amortization calculators can be found on most mortgage-related websites. You can copy and paste the results into a spreadsheet program, and then perform the additional calculation of subtracting the monthly payment differences fromꦏ the new mortgage’s principal balance.

An Example of the Household Net Worth Method

Using the above-described calculations, a refinance analysis of an existing mortgage with a fixed interest rate of 7%, 25 years remaining until repayment, and a principal balance of $200,000 into a new 30-year mortgage with a fixed interest rate of 6.25% and refinancing costs of $3,000 (which will be rolled into the new mortgage’s principal balance) gives the following result🌃s:

If a simple payback period analysis is used to determine the economics of refinancing in the above example, the cumulative monthly payment savings are greater than the $3,000 costs to refinance beginning in month 19. In other words, the simple payback period method tells us that if the homeowner expects to have the new mortgage for 19 or mor🍷e months, refinancing makes sense.

However, if the net worth approach is used, the refinancing decision would not become economical until month 29, when the principal balance of the new mortgage minus the cumulative monthly payment savings is less than the principal balance of the existing mortgage. The net worth approach tells us that it takes 10 months longer than the simple payback period approach before the refi💫nancing is economical.

Special Considerations

Keep in mind that during periods when home values decline, many homes are appraised for much less than they were previously worth. This may cause you to not have enough equity in your home to satisfy the 20% down payment on the new mortgage, requiring you to come up with a 💮larger🎀 cash deposit than expected.

It could also require you to carry private mortgage insurance (PMI), which will ultimately increase your m൲o♉nthly payment. In these instances, even with the drop in interest rates, your real savings may not amount to much.

The Bottom Line

By calculating the actual economics of refinancing your mortgage, you can accurately determine the payback period with which you have to contend. Crunching the numbers takes a bit 🐲of work, but anyone can do it.

Especially if you are planning on moving in the next few years, taking a few minutes to calculate the actual economics of refinancing your mortgage may very well help you avoid damaging your net worth by thousands of dollars. And if it does look like 澳洲幸运5官方开奖结果体彩网:refinancing will pay off, yꦜou will have a much clearer understanding of exactly when you will start benefiting from thi𒉰s move.