Editor’s note: This is the second of a two-part series.

In the first article of this series, I suggested that the net benefit of a refinance to the borrower should be measured by the net present value (NPV) or net future value (NFV) of all benefits and costs. Whether the refinance increases or decreases the rate at which the loan balance is paid down is an important but often overlooked benefit or cost that should be captured by a refinance calculator.

Testing calculators

I use two examples to test how a calculator works. In one I assume a significantly lower rate on the new loan and low refinance costs, but the new loan carries a 10-year term and therefore a higher payment than the old loan. The calculator should recognize that this is a great refinance for the borrower who can afford the new payment because of the rapid paydown of the balance.

In the second test scenario, the new loan has a higher interest rate than the old loan but because the new term is much longer than the remaining term on the old loan, the new payment is lower. The calculator should recognize that unless the borrower needs the lower payment to avoid default, the refinance is a loser because of the much slower reduction in the balance.

Early Web-based calculators

I first looked at Web-based refinance calculators about 10 years ago when I found a fairly consistent error in most of them. They defined the breakeven period as the cost of the new loan divided by the reduction in the monthly mortgage payment. In my first test scenario, they erroneously told borrowers that this refinance was a loser.

This approach panders to the preoccupation of many borrowers with the monthly payment, and it is wrong. It totally ignores differences between the old mortgage and the new one in how rapidly the loan balance is paid down.

Current Web-based calculators

Recently, I set out to see what difference 10 years has made. To select the sites, I entered "mortgage refinance calculators" in Google and examined the first 10 that appeared. These are among the most widely used calculators, and several of these sites are in the business of licensing their calculators to other sites.

HSH.com and Bankrate.com continue the erroneous practice of measuring breakeven as the ratio of refinance cost to payment change. These are very good websites, but don’t use their refinance calculators.

Calculators4mortgages.com uses total interest payments as its sole measure of the net benefit from refinancing, which also ignores changes in the balance. This site, furthermore, considers the down payment to be part of the refinance costs, which is nonsensical. Don’t go near this calculator.

LendingTree.com has a payment calculator only and should never have come up in my search.

Five sites calculated the breakeven period as the ratio of refinance cost to the cumulated monthly interest savings, a measure I had never seen before. After dissecting it, I concluded that this measure is not as good as NFV because it does not explicitly take account of differences in balance paydown, but it does do it indirectly and the error is small.

Those five sites are:

These are all acceptable calculators.

The best of the lot, however, is mortgagecalculator.org, the only one of the 10 that uses NFV to measure the gains and losses from refinance. However, this calculator does not include lost interest or mortgage insurance, and does not allow the user to include refinance costs in the new loan balance, or make extra payments. My calculator 3a does all that, but it doesn’t come up in the first 10.

Refinance issues most calculators don’t cover

The 10 refinance calculators examined above all focus on the question of whether it pays to refinance one fixed-rate mortgage into another. None deal with any of the following situations:

  • Borrower wants to lower his rate, but has two existing mortgages to be refinanced into one or two new mortgages.
  • Same but borrower also has short-term debt to be refinanced into one or two new mortgages.
  • Borrower wants to raise cash and needs to compare the cost of a cash-out refinance with the cost of a second mortgage.
  • Borrower has an adjustable-rate mortgage and wants to compare the cost of refinancing into a fixed-rate mortgage with the benefit of reduced payment risk.
  • Borrower wants to know whether paying down the loan balance to lower the cost of the refinance is a good investment.

I have calculators on my site that deal with these less common but still important refinance situations.

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