How to Know When to Refinance Your Mortgage
When To Refinance Your Mortgage
By Cindy Diccianni, RN CSA
When does it make sense financially to refinance your mortgage? Oftentimes, even when interest rates drop, the answer is no. It depends on your personal situation. There are several factors to consider before you refinance. Not giving proper consideration to all aspects of the decision can cost you. Consulting with a financial advisor can save you thousands - if not tens of thousands - of dollars.
Considerations For Refinancing
Here are several aspects to take into consideration. Evaluate all of these factors collectively before making your decision.
- Can you lower the interest rate on your mortgage? Many people feel that a 2-point interest rate reduction makes refinancing a mortgage a good idea.
- How much longer you will be staying in your home? If you will be moving in the next 3-5 years it may cost you more to refinance than it is worth.
- How much longer you have to payoff your existing mortgage? For example, if you have only five years left on your existing mortgage at 9%, it will not make sense to refinance a short-debt into a long-term debt even if you drop your interest rate down to 7%. In this situation, it makes sense to pay-down your principal by adding additional payments to your mortgage each month.
- How much will you need to borrow? In some cases a small decrease as little as a quarter of a percent can be justified, especially for larger mortgages.
- What are the closing costs, including points assessed? To calculate the time frame it will take to recuperate your costs, first determine how much lower your monthly payments will be with the lower rate; mortgage calculators can be found on many mortgage web sites. Then divide your closing costs by your monthly savings. This will tell you how many months it will take to recoup your costs. Once you get past this recovery period, you will begin to see savings from the refinancing.
- Is your current mortgage open-ended with no prepayment penalty clause? If not, it may not be worth terminating your agreement.
- Do you need to do some home improvements? Caution here if the improvement will not increase the value of your home. Additions while nice may not bring you the increase in value that you may think. Renovations to kitchens, bathrooms and family living space additions will bring the greatest value to a home.
- Do you have an adjustable rate mortgage (ARM)? Variable rate mortgages are more volatile in this market. While the rates are low it is wise to lock in with a fixed-rate product. Watch for the conversion clause in this type of mortgage, the fee to convert is an added expense for you. It's best to compare other fixed rate mortgages available.
- Do you have other high interest rate debt or debt that is currently nondeductible? It is never a good idea to payoff short-term credit card debt with a long-term debt like a mortgage. Likewise, you don't want to pay high, nondeductible rates on debt.
The best-case scenario is to payoff the debt with existing cash. If this is not possible, then a home equity loan or line of credit is the best avenue. The interest is deductible and the loan is short-term. Remember not to generate new credit card debt once you have refinanced the existing debt. If you don't change the spending habit patterns that got you here in the first place, you'll wind up in debt all over again.
The annual percentage rate (APR) is not the same rate as the interest rate on the loan. It reflects the total cost of the loan, including points and other fees that the lender will charge you. It provides you with a standard way to compare costs.
Interest rates change constantly. The best rate is the one that can help you the most financially. Take all of the costs into consideration and don't forget the points, if any; the best refinancing has no points at all.
Important facts to consider regarding points are the following:
- Can you can recoup the cost of the points in a reasonable time frame (see #5 above)
- Should you pay the points at settlement?
- The points that you pay in a refinance are not deductible in the year they are paid but are amortized over the life of the loan.
- If you have remaining points from a previous refinancing (this information is on your tax return), then you can deduct those points when you refinance again.
Having the right partner to walk you through this process is critical since you are dealing with potentially tens even hundreds of thousands of dollars. Always use a lender you can trust and feel good about doing business with. You want to be sure the rates that they quote you are actual rates, not an enticement to get your business. The best way to find a good mortgage lender can be through your financial advisor, accountant, lawyer or banker.
Cindy Diccianni is a nurse, a certified senior advisor (CSA), a registered investment advisor and a registered representative with Leigh Baldwin & Company member NASD and SPIC. She is affiliated with Ortner, O'Brien & Ortner Advisory Group, Inc. Contact Cindy at firstname.lastname@example.org.
Copyright 2002 by Cindy Diccianni.