What to consider before refinancing

The most compelling reason to refinance is to save money. Suppose you currently have a $200,000, 30-year mortgage with an interest rate of 8.5 percent. You find you can refinance into a 7.5 percent mortgage. This will save you $140 per month. But before you do it, consider how long you plan to stay in your home and how much the lender will charge to refinance. 

Lenders usually charge "points". (One point is equal to 1 percent of the loan amount.) No-point loans are available but usually the trade-off is a higher interest rate. 

In addition to points, you'll probably have to pay for the following: title insurance to protect the lender, an appraisal, a credit report, as well as miscellaneous processing and documentation preparation fees. These fees are usually charged even on a no-point loan. 

Let's say you'll have to pay a total of $3,000 to refinance, when all fees are taken into account. The next step is to multiply the monthly savings ($140 in the above example) by 12 months. $1,680 is the amount you'll save in one year if you take the lower interest rate loan. 

Then multiply the annual savings by the number of years you plan to stay in your home. Subtract the lender fees from this figure to determine how much you'll really save by refinancing. In our example, you would have to stay in your home about two years before you would save any money by refinancing. 

Some homeowners refinance to trade in an adjustable rate mortgage (ARM) for a fixed-rate loan. ARMs make some people nervous. There may be no cost-savings attached to refinancing to get out of an ARM. In fact, the new fixed-rate loan may have a higher interest rate. The reason for this type of refinancing is peace of mind. 

Another reason to refinance is to tap some of your equity to use elsewhere: for example, to consolidate debts or pay for college tuition. Let's say you currently have a $200,000 mortgage, but your property is worth $350,000. You refinance with a new $250,000 mortgage and the lender gives you $50,000 when the loan closes. 

Most lenders will only give you cash back with your new mortgage if you have sufficient equity remaining in the property, after the higher loan balance is taken into account. You'll also have to qualify to make the higher monthly payments. 

FIRST-TIME TIP: Homeowners who have been paying on their current mortgage for years need to consider another factor. When you refinance, your mortgage will be amortized over a new loan term (typically 30 or 15 years). By keeping your current loan, you may own your property free and clear of a mortgage sooner. 

You also may pay less in interest. Let's say you have a 15-year fixed-rate loan. You've been paying on that loan for 4 years. Your current interest rate is 7.25 percent and you pay $1,847 per month. 

You can refinance with a new 6.625 percent mortgage. It'll cost 1 point. The new monthly payment will be $1,466--almost $400 per month less than you currently pay. Sounds great. 

The calculations tell a different story. The total cost of the new loan will be approximately $268,000. If you keep your current loan, you'll pay $243,804 over the next 11 years. Clearly, it doesn't make sense to refinance if you're planning to stay in your home. 

THE CLOSING: Don't get caught up in the refinance frenzy and refinance just because every one else is doing it. First, make sure it makes good sense financially. 

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