When Should You Refinance?

November 10, 2011

There are several reasons why a homeowner may wish to refinance. When you refinance all you are doing is obtaining a new mortgage to pay off some or all of the existing mortgage. In some instances this could save a substantial amount of money over the long run.

[Kevin] So long as you don’t refinance in order to take on more debt!

There are homeowner loans that can provide lower interest rates than the original mortgage. This can make a dent in monthly payments and add up to a substantial amount of savings over the life of the mortgage. Even 50 basis points less in the interest charge can have an impact if you are planning on staying in your home at least five years. For example, a $100,000 mortgage will receive a savings of $420 a year if the interest rate goes from 8.5% to 8%. You could use that money to invest in your savings account.

There are some costs involved in refinancing that should be taken into consideration. There are closing costs associated with the new loans. These costs vary between different lenders; a loan of $100,000 can mean closing costs of up to $1,800. If you can recoup that money fairly quickly, then refinancing might be worthwhile. To find out how long it might take to recover that money you can divide the closing cost by the monthly savings of the new mortgage.

You also need to balance savings against possible lengthening of the mortgage term. If you take out a new loan for 30 years you have added on many years before you will be mortgage-free. One option is to take out a shorter loan and another is to invest the difference from the 30-year mortgage.

Another way of saving money is seeing if you are still paying PMI, which usually applies if you put a downpayment of less than 20% of the home’s sale price. You can stop paying PMI if the mortgage is now 80% or less of the home’s value. This may be accomplished without having to refinance. At the same time, you can also extend your debt with a HELOC and use the additional cash to fund college education for your kids, or to pay off high-interest rate debts. This route should be taken with caution. It will stretch out the payments and may put your house in jeopardy.

[Kevin] I might see the value if you pay off a high-interest rate debt with a low-interest rate debt, but I would otherwise use a HELOC with great caution. Home prices do not go up in a straight line.

Refinancing can also allow you to change the terms of your mortgage. Switching from an adjustable-rate mortgage to a fixed-rate loan or shortening the term of the mortgage may make financial sense to you. This can also allow you to switch to a conventional loan from a jumbo loan. The bottom line to determine if you should refinance is to take the savings that you are likely to obtain into consideration. If it makes financial sense, refinancing may be an option.

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Written by Jo & Ray · Filed Under Real Estate 

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