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HomeHomes
Published: Friday, 12/4/2009

When To Refinance Your Mortgage

BY DON TAYLOR, PH.D., CFA
BANKRATE.COM

The chance to refinance a mortgage at a lower interest rate is sure to get a homeowner's attention. But it's not always the right decision.

Having bragging rights at the neighborhood picnic isn't a reason to refinance. Instead, it's good to put some thought behind the timing of your decision.

Multiple refinancings can reduce your overall financial benefit. Refinancing junkies who always migrate to the next low rate pay a hefty price by leaving a trail of closing costs in their wake.

In some cases, a mortgage refinance makes sense. In other cases, it may be more prudent to stick with your current mortgage.

What's Your Goal?

Before deciding whether to refinance, you need to determine what you want to accomplish. Remember, a refinance doesn't pay off the debt; it just restructures it, often at a lower interest rate and a different loan term than the current mortgage.

Reducing the interest expense is the most common goal of a refinance. But some homeowners also appreciate the ability to extend the loan back out to 30 years, reducing the monthly payment.

Debt consolidation is another goal of refinancing. If you have both a first mortgage and a home equity mortgage, combining the two mortgages into one fixed-rate mortgage levels out the payment over the loan term.

Many homeowners refinance because they want to get out of (or into) an adjustable-rate mortgage. In high interest rate environments, homeowners are attracted to ARMs because they typically are at a much lower interest rate than a 30-year fixed-rate mortgage.

On the other hand, in low interest rate environments, the differential between the fixed-rate and the ARM isn't as great, and homeowners like the security of locking in a fixed rate over the mortgage term.

When To Refinance

After clarifying your reasons for refinancing, you need to consider whether the timing and circumstances make this the right time to get a new mortgage.

Usually, you have to plan to be in the house for awhile for refinancing to make sense. According to Bankrate's 2008 closing cost survey, the national average for closing costs on a $200,000 loan is $3,118. The fees in the survey don't include taxes, insurance or prepaid items such as prorated interest or homeowner association dues.

When weighing whether to refinance, homeowners typically are urged to consider how many months of lower payments it will take to recoup the closing costs of the new mortgage.

For example, if your monthly payment goes down by $156, it would take 20 months of lower payments to recoup the average closing costs.

Tip: Know Where You Stand

Before you refinance, know where you stand with your current mortgage -- including the loan terms and interest rate, as well as relevant factors such as your credit score and whether or not the loan has a prepayment penalty.

While this is not a bad rule of thumb, it doesn't really measure your savings. Savings come from a lower interest expense, not lower monthly mortgage payments. You'll see that if you get a lower interest rate but extend the mortgage term, you can wind up spending more in interest. For example, replacing a mortgage that has 20 years remaining with a 30-year mortgage will result in higher interest expense over the life of the new loan.

To figure out whether refinancing with a loan term extension will help you save, do two calculations: one where the new loan has the same term as the old loan, and one where the new loan is the length of your planned refinance. Compare the interest savings to see if refinancing accomplishes your financial goal.

Some people refinance simply to make the monthly mortgage payment more affordable. A lower interest rate and/or a longer loan term both work toward lowering the monthly payment. As long as the homeowners understand they may not be minimizing total interest expense, affordability can be a motivation for extending the loan term.

While short-term savings are important, they are not the only factor to weigh when considering a refinance. Refinancing to get out of an ARM, piggyback mortgage, interest-only mortgage or other onerous mortgage provisions may be reason enough to take on a refinancing.

However, in some cases, homeowners with ARMs would be fine sticking with their loan, especially if they don't plan on being in the loan long term and the reset rate on their mortgage isn't financially threatening.

The Mortgage Professor, Jack Guttentag, has refinancing calculators on his Web site that allow homeowners to estimate the benefits of switching to a mortgage with new terms, including a calculator that can help reveal whether it makes sense to convert an ARM to a fixed-rate mortgage.

When Not To Refinance

On the other hand, a little number crunching may indicate that refinancing is not right for you at this time.

If you don't plan to be in the house for very long, you should probably stay in your current mortgage. Here, the number of months it takes to recoup closing costs becomes the more important calculation done by the refinancing calculator.

You also should reconsider a refinance if you're underwater on your mortgage at this time. Borrowers in this situation are unlikely to find a lender willing to offer good terms on a refinance. However, it is possible that a present or future government program could allow you to refinance at more favorable terms.



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