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June 30, 2013

Should we pay off son's college debt?

(Continued)

First, calculate the amount of money you’ll save as a result of a refinance. The way to do this is by multiplying the interest difference by your loan balance. If you have a $200,000 mortgage on a 5 percent loan, and you refinance to a 3 percent loan, that will save you 2 percent per year, or $4,000. Next, look at the refinance costs. What are the closing costs in order to refinance? If it’s $10,000, and you divide that by $4,000, that says it would take two and a half years to get your money back. If the costs are $8,000, it would take you two years to get your money back if you’re saving $4,000 a year. That’s pretty substantial!

What I just laid out is called a break-even analysis. Basically, it answers the question of how long it will take you to get back the money you spent on closing costs with the interest you save. That will give you the answer as to whether or not you should refinance again.

So there’s not really a “You’ve done this too often” rule. If you refinance three times in a year it would only be smart if interest rates have dropped significantly throughout that time. Doing a refinance to save an eighth of a percent won’t work out well for you.

Dave Ramsey is America’s trusted voice on money and business. He’s authored four New York Times best-selling books: “Financial Peace,” “More Than Enough,” “The Total Money Makeover” and “EntreLeadership.” Follow Dave on Twitter at @DaveRamsey and on the web at daveramsey.com.

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