When Should I Refinance?


By: Diane St. James

This is a question that is on every homeowner's mind at one point or another during the life of their mortgage, unless you got your mortgage when the rates were down below 6.5% in the fall of 1998 for that short period of time.

So when the rates looks attractive and you start wondering if you should jump on the bandwagon and refinance, what makes you decide?

First let me tell you it is a matter of preference. Some people want to refinance even if the rate has dropped only 1/4%-1/2%, so their payment doesn't drop by a whole lot. I usually tell my clients that they should wait until the current rates are 1% or more lower than the rate they currently have. Why is this? If you don't remember from the first time or second time around, it is called closing costs.

You should think twice before you refinance for a mortgage that has a lot of closing costs associated with it. And don't let the lenders fool you. When you hear "You can roll it all into the loan" amount, that may very well be true. What you don't hear is the rest of what isn't said...."and watch all the equity you've built up in the past few years go away in the blink of an eye."

Let me give you an example. Lets say you took out a mortgage for $135,750, at 7.375% 2 years ago. I know, I usually use easy examples, but there happens to be an amortization schedule in a loan I am working on right now, so I'm just going use that...prevents me from having to use my calculator for once :)

If you made your regular mortgage payments faithfully for 2 years, your current mortgage balance would be $132,967. Okay then, that's good, you're starting to chop away at this mortgage monster that threatens to tie up a good chunk of your pay check for the next 30 years.

Now you want to refinance and the closing costs involved are $3000. No problem, no out of pocket costs. Just add that to the new loan amount. Wait a minute, now you are at $135,967, and you just lost all the equity you've worked so hard to get to for the last 2 years. In fact in this example you owe more. <gulp> Okay, well you didn't really lose ALL the equity you built up, because hopefully your home went up in value too, so you still have gained some equity.

If you can get a mortgage that has No closing costs and still lowers your monthly payment, I say go for it. I've heard of these programs, but I haven't personally seen any of them. Some lenders say no closing costs, and then charge at least 1/2% or more in the interest rate to help disguise the closing costs. After so many years of the mortgage, that lender has made up what they would have charged in closing costs, in the additional interest charged on your mortgage.

When you are shopping rates to refinance, ask what the estimated closing costs would be. Then using your trusty calculator, figure out how many payment it will take you to 'make up' for those closing costs alone. For instance, if by refinancing you will be saving $30/month, and the total closing costs are $3000, divide $30 into $3000 and that is how many payments it will take to 'cover' the closing costs. In this example it would take 100 months which translates to 8.33 years time. Now I know there are other factors to be considered, like if you put that $30/mo. that you would be saving by refinancing, into a mutual fund every month, what would the value of that monthly $30.00 be in 8.33 years? But really, how many of you would actually do that? Thought so.

So if you are thinking about refinancing here are some pointers. Check out not only the rates, but what the closing costs would be. Unless you really plan on staying in your home a long time, don't bother paying points to lower the monthly payment more. This can really increase your closing costs.

Do the calculations mentioned above, to see how long it will take you to break even with the closing costs you're going to be paying. Is it worth it to you? Think about how long you are going to be in the house. If it is only going to be another 3-5 years, it may not be worth it.

If you have an FHA loan, and the rates are currently lower, it would be a great time to refinance, because FHA lowered its upfront MIP (mortgage insurance premium) to 1.50%, down from the 2.25% it used to be. If you took out your first mortgage just a few years ago, you will be entitled to a rebate on some of that up front payment you made before (often it gets applied) to the new MIP, but still a good deal.

If your mortgage the first time around involved PMI, but it has only been a few years and you are thinking of refinancing, look into getting a combo loan. This would be a first mortgage for 80% of the mortgage balance based on the value of your home, and a second mortgage for the remaining balance of your old mortgage. Sometimes just getting rid of PMI can make it worthwhile.

One final word. Don't get greedy as far as interest rates are concerned. If you've done your calculations and think it is worth it for you to refinance, but you are just not sure whether the rate is 'good enough,' just think about back in early 80's when the rates were in the double digits! That is when I got my very first mortgage and was LUCKY to assume a 10.25% FHA loan!

Diane St. James http://www.abcmortgage.net KNOWLEDGEABLE, FRIENDLY AND CARING MORTGAGE ADVICE Author of "How to Get a Mortgage" New ezine Diane's Mortgage Tips + Other tidbits mail to: DMortgagetips-subscribe@topica.com

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