If you’re looking for a new home loan, your potential lenders are likely selling you with lower monthly payments, lower rates, and a longer term. However, as the refinancing decision maker, you should do your own due diligence on whether or not this is something worth pursuing. Now you can do this subjectively or simply by saying that since the new one will require lower monthly payments, then that’s fine.
It’s wise to do the numbers, and as the choice maker, you need to study these simple steps to objectively determine if this is worth your while. The main idea is to compare the net present value (NPV) of each refinancing plan. You get your closing costs and add the present value of future cash inflows from the savings you’ll realize. You can do this with Microsoft Excel or any standard spreadsheet program.
For each plan, calculate the monthly or annual payments (principal and interest included). Subtract the monthly payment or annual payment of your current plan with the other options you have. The result is the monthly or annual savings.
Put columns to represent each year. It is important that you compare terms that have the same duration with the year 0 as the present tense. Put the annual payments you will have to make for each column (starting with year 1), one refinance option per row. For example, for row 1 you will have the #1 lender and then the annual payments in each of the columns. For year 0, put in the closing costs and make sure it’s a negative number (representing an exit). Use Excel’s NPV function and select all (present) and (future) cash inflows and use a conservative rate like 4% to 5%, which is something you can easily get just by investing in CDs.
The higher the NPV, the better, as it represents the value of future savings in today’s time taking into account the net effect of closing costs.