Refinancing Your Mortgage
Radio airwaves, magazines and newspapers are filled with advertisements from lenders encouraging homeowners to refinance their home mortgages. These messages extol the virtues of switching from Adjustable Rate packages to fixed mortgages to lock in lower interest rates. The question is: would refinancing your mortgage really be the right move for you?
Rise of the Refi
Interest rates have fallen dramatically since the first of the year, and as a result mortgage refinancing has been gaining steam across the country. Applications to refinance existing mortgages have been on the rise in recent weeks. Many of these homeowners are just as attracted to the possibility of getting out of riskier Adjustable Rate Mortgages as they are to lower rates.
Whether or not you should refinance your mortgage depends largely on your personal circumstance. Most important are the interest rate and terms of your current mortgage as well as your outlook (how long you intend to own your home).
The conventional wisdom has always been that you shouldn't refinance until the interest rate has dropped a full point (or more) below what you're currently paying. The basic theory behind this advice is sound enough: given the typical costs associated with refinancing, chasing lower interest rates is only financially sound once the rates drop below a certain threshold. But the old rules fail to take into account some of today's situations, such as owners wanting to switch from an ARM to a fixed rate mortgage or those eyeing a "no-cost" refi.
Things to consider
As with most money matters, there is no "one-size-fits-all" answer to the refinancing question. If you're considering refinancing, consider these elements:
Rate - Interest rates have been dropping throughout 2008, and a large number of homeowners are seeking to take advantage by locking into lower rates. Some believe that it is better to wait and see if rates will continue to drop, owing that the general trend has been downward. On the other hand, the current rates are a known commodity that you may wish to take advantage of.
Risk - Historically the main motivation for refinancing a mortgage has been to secure a loan with a lower interest rate. But many homeowners are now seeking to refinance mainly for the kind of security that ARM products typically can't offer. If you have concerns over future fluctuations or spikes in interest rates, you may wish to lock in a fixed 15 or 30 year fixed rate mortgage, particularly if there is no annual or lifetime cap on the amount that your current loan can increase.
Term - In addition to the rate and structure of your loan, take into account the term of your current loan and any potential refinance. For example, if you've already paid off eight or nine years of your current mortgage, you might find opportunity in a fixed 15-year or 20-year loan as opposed to the more common 30-year product. In general, extending the total term of your loan will negate the benefits of lower interest rates, so try to keep the bigger picture in mind.
Closing Costs - As with primary mortgages, refinancing a mortgage entails up-front expenses. Many lenders are offering refinancing packages with modest out-of-pocket expenses. Even if lower than average, these costs may be substantial and additional fees may be added to your loan balance. Some lenders are even offering "no-cost" refinancing in order to attract homeowners. Remember that in such cases you'll likely not get the lowest interest rate available in the market. Be sure to carefully weigh the benefits of any "no-cost" package against those of traditional refinances available to you.
The Break-Even Point
Unless you've secured no-cost refinancing, you'll need to weigh the cost of the new loan against the amount you'll save over the term of the loan. One simple way to determine if refinancing is in your best interest is to determine the amount of time (with your monthly savings) it would take to recoup any fees or closing costs.
To start you'll need to determine your (potential) monthly savings. Review your payment coupon to verify the amount of your current monthly interest and principal. After establishing the rates and loan packages that you qualify for, ask your loan officer or mortgage broker for an estimated monthly payment. Many online mortgage calculators can also help you determine monthly costs if given the principal loan conditions.
You can now use that monthly savings to determine the point at which you'll begin to see a real return. For example, say refinancing will entail $2000 in costs but will save you $50 every month in payments. If you divide the mortgage fees by the monthly savings you find that the "break-even" point is 40 months from now. After that point the monthly savings would no longer be mitigated by the up-front costs.
Again, your personal situation determines whether or not the prospect of refinancing is truly viable. If you plan to own your home for many years or the cost of refinancing is very low, then you're more likely to realize the benefit of securing a new mortgage.