Why inadvertently pay thousands and thousands of dollars on a mortgage when you can save money by choosing the proper time to refinance your loan?

Here’s how it works:

Lower interest rate

Refinancing makes financial sense, as the new loan may result in at least a 1 percent decrease in your interest rate. If you are currently paying a mortgage with an 8 percent interest rate, and you found a new mortgage with an interest rate of 6 percent, you’ll be saving 2 percent!

Let’s say, your current mortgage is $100,000 with an APR of 8 percent per annum, payable within 30 years. If you refinance it at 6 per cent per annum, with a loan term of 30 years, but with an APR of 6 percent you can save $134.21 a month! That’s $1610.52 a year or a total of $48,315.6 for 30 years!

You can use the significant monthly savings to build your emergency fund or invest it in bonds with at least 4% monthly interest to gain a substantial amount of money in the long-term.  The savings could also be used in a number of ways, such as saving for huge expenses or reducing debts.

But, be careful when choosing a lender. There are many factors to consider when making a refinancing decision. It is like buying a house for the first time—you have to look at the overall cost of the loan. Don’t just look at the lower interest because there are other fees that may make the loan more costly than you thought it is.

Changes the term of your mortgage

How long is the payout period of your current mortgage? Refinancing is a good idea if you can shorten the term of your mortgage.

In the example above, let’s say you have $100,000 mortgage with an APR of 8 percent payable within 30 years. You refinance it with the same amount and interest, payable within 25 years. That means you can save $44, 025.6! This is an astounding number considering the principal was only $100,000. Just imagine how money you can save if you reduce the interest to 6 percent.

Some borrowers are too focused on the monthly payment that they forget the cost of borrowing added to it. You might be surprised at the amount of interest you have to pay over the loan period. You have to pay a lot of interest on top of the principal over the term of the loan.

It may shorten the break-even point

How many months will it take to recoup the cash you will use to refinance your loan? You have to consider the following fees:

  • Application fee
  • Appraisal fee
  • Attorney’s fee
  • Credit Check
  • Document preparation
  • Inspections
  • Local fees
  • Points and its costs
  • Title Insurance
  • Title search

In calculating how long it will take to recoup the cash you will spend, you have to look at the amount of money that will be saved by refinancing.

To get the “break-even point” you have to divide the cash you will spend to refinance by the monthly savings. The result would be the pint at which you will realize the savings refinance makes possible.

Let’s say the cost of refinance is $5000. If you refinance your $100,000 mortgage at 8 percent APR with a 6 percent APR, and save $134.21, it would take around 37 months for you to realize the savings. To recoup the cash you used to refinance, you need to make payments on your mortgage for 37 months or 3 years and 1 month. But considering the interest saved by the reduced APR and reduced loan term, you have made a wise financial move.

Is refinancing a wise move?

In most cases, people refinance their homes to take advantage of lower monthly payments. This happens when they are struggling with their finances because of changes in their financial situation brought by divorce, job loss, sickness and other situations. Others opt for refinancing because they want to create extra money for a vacation, debt repayment or to buy a car or other big ticket items.

Sometimes, refinance can add to their total debt and lengthen the term of the loan. That is why it is very important to have a financial plan in place, to make sure that you money will be put to good use. Otherwise, you’ll defeat the purpose of refinance -which is to help you save money and to build a strong financial portfolio. It also helps to weigh your options—don’t jump at the first lender offering reduced monthly payments. Look at the overall picture. Try to gauge if an option can help you lover the overall cost of the loan, or simply tries to lure you with reduced monthly payments, only to blast you with high fees and charges, plus a longer loan term.