Have you ever received one of those letters in the mail that tells you how you can save nearly $250 per month if you refinance your mortgage with their company?  No closing costs, low rate—sounds great, right?  Well, before you sign the paperwork on this, you need to read the fine print.  Saving $250 a month sounds great.  With the ever-increasing costs of food and other consumer goods, getting a break in the budget can be quite tempting.  But how do you know if refinancing your mortgage is a good deal?

There are four major details of the offer that are important to know before deciding if it is a good deal or not:

1. Rate—Make sure that the low rate the bank is offering is fixed, so that it doesn’t fluctuate after an introductory period. If it is only a three-year fixed rate and then adjustable after that, your $300 per month savings will dwindle quickly once the rate adjusts.  In fact, depending on the terms of the loan, the rate can adjust, only a certain amount each year, but could end up being several percentage points higher than the original introductory rate.
2. Loan Points—Are you having to pay points to buy the rate down to the low rate that is being advertised. If it is going to cost you several thousand dollars, even if the amount is rolled into the loan, then the costs could end up out-weighing the benefits.
3. Closing Costs—Does $0 closing costs really mean there are no closing costs? While you may not be expected to come up with closing costs out-of-pocket, they may be rolled into the loan or there may even be a large pre-payment penalty if you sell your home or refinance within a certain amount of time.
4. Term—what they don’t usually point out in big, bold print on those marketing letters is that it in order to achieve the $250 per month savings, you are going back to a 30 year term on your mortgage. If you have already been paying on your current mortgage for 10 years, going back to a 30 year term may actually cost you money.

So how can you figure out if the offer is a good deal?  Follow these simple calculations, and you will know for sure:

Example Scenario: Current mortgage—30 year fixed rate of 5.5%, $150,000 original loan amount, with an $852 monthly payment (principle and interest only—do not include any portion that is paid to homeowner’s insurance), and you have been paying on it for 10 years (120 payments).  What you need to calculate is how much you have already paid (total of payments), what you have left (mortgage payoff balance), and total cost of payments of both mortgages.

Calculate Total of Payments:

Monthly Payment x Number of Payments = Total of Payments

$852 x 120 months = $102,240

Calculate Mortgage Payoff Balance:

This is easy because the remaining balance should show up on your monthly mortgage statement.  However, you would want to call your mortgage company for an exact payoff amount because if there is any prepayment penalty that would have to be added to the balance.  You can also use an amortization calculator to estimate a payoff balance.

$123,527 Mortgage Payoff Balance

Calculate Total Cost of Payments of Current Mortgage: 
(Yes, this is a big number!  You should have seen it on the Truth-In-Lending when you signed your original mortgage papers)

Monthly Payment x Term of Loan = Total Cost of Mortgage

                                $852 x 360 months = $306,720

Calculate Total Cost of Payment of New Mortgage:  If your new mortgage is going to save you approximately $250 per month, (with a lower rate of around 4.17%), then your new principle and interest payment would be $602 per month.

                Monthly Payment x Term of Loan = Total Cost of Mortgage

                $602 x 360 months = $216,720

The cost of this new loan is lower, however, you need to add the amount that you have already paid to this balance because it is actual cost to you—which you have already paid.

$216,720 + $123,527 = $340,247

Now, just compare the two Total Cost of Mortgage values:

Current mortgage, total cost of mortgage: $306,720

Potential New Mortgage, total cost of mortgage: $340,247

So even though the new loan offers a lower rate and monthly savings, by taking you back to a 30 year term, you will actually pay more than if you kept the current mortgage that you have.  So if you are comfortable with your current payment, keep the current mortgage that you have; if however, your situation has changed and you absolutely need the monthly savings it might make sense to make the change.  You can always pay more toward the principle once your financial situation allows it again.