How to Determine If You Should Refinance Your Home

At the time this article is being written (late November 2008), the Federal Reserve bought large amounts of mortgage backed securities causing a rapid drop in home mortgage interest rates. This has lead to a flurry of refinancing of home mortgages. Many are now asking themselves if it is time to refinance their own home. Here are some steps to determine if it is right for you.

	Determine how long you plan to stay in your current home. Since your mortgage is tied to a particular home, good interest rates now will be of no use to you if you sell the home, since financing a new home will be at the interest rates of the time that you buy the new home. If your house is on the market, or if you plan to sell it in the next year or so, any potential money saving will probably be erased by the hassle of getting the new mortgage and all the closing costs and miscellaneous costs involved.
	Do research into rates that you could get. Zillow.com in their mortgage section allows you to get mortgage quotes without giving any personal information to the mortgage broker, but rather only information such as the loan amount, your income level, your estimated credit score/creditworthiness, etc.
	Determine your annual savings in interest paid. Note: you are not interest in how much more or less the payments will be. For example, if you go from a 30 years to a 15 years mortgage, your payments will go up, but if the interest rate is lower, you'll save money anyhow because more of your payment will go to principal. Here is a rough way to calculate the savings. (Note to math and finance people: I know this is an approximation!) Take your loan balance and the interest rates of the old a new mortgages. Subtract the new rate from the old rate, and multiply that by the mortgage balance. That is your annual savings. Remember that 2% means .02 and 4.25% means .0425. Keep that in mind when multiplying to avoid seeing extremely inflated savings numbers. Here's an example. Assume you still owe $200,000 and your current interest rate is 6.5%. Assume furthermore that you can now get a loan for 5.25%. Old rate - new rate = 6.5%-5.25%=1.25%. $200,000*1.25% = $200,000*.0125=$2500. So, in this example you would save about $2500/year in interest payments.
	Calculate all closing costs. These can vary widely! Some banks offer rebates on closing costs, and others don't. Make sure you consider both interest rate and closing costs when decided on a mortgage. Remember to include attorney and appraisal fees if any are involved. Some say a good rule of thumb is that closing costs are about 2%-3% of the loan amount. In our example of $200,000, that would mean $4000-$6000.
	Determine how much money you would save, if any. Take your annual savings and multiply it by the number of years you expect to stay in the home. Assuming the example homeowner plans to stay in the home for 5 years, then the savings of $2500/year works out to $12500 over 5 years. If closing costs $5000, then you would save $7500 over 5 years, which might be worth it. However, if the example homeowner only planned to stay in the house another two and a half years, then that would only be $6250 in interest savings, but $5000 in additional costs, and that would probably not be worth the trouble.
	Determine if your current mortgage has any prepayment penalties. If it does, add them in your calculations to your "closing costs". If you want to refinance anyhow, call up the current mortgage company and see if you can negotiate away the prepayment penalty. Most mortgages with prepayment penalties are subprime, and the lender may want you to refinance to eliminate the mortgage that is now worthless on their books.
	If you are in an adjustable rate mortgage and plan on staying in your house for more than a year, then you should certainly refinance, even if the new mortgage has a higher rate than what you are currently paying. Interest rates are at very low levels now, so you should expect your adjustable rate mortgage to adjust upward, and you can stop that risk by refinancing into a fixed rate mortgage now.
	If your monthly mortgage payment is going to go down, make sure you have a plan for the extra money each month. If you have no plan, it will walk away from you. Pay down non-mortgage debt, save for emergencies, or even work on paying off your house early. If you just waste the money, then any savings from refinancing will be eliminated.

• Don't pull equity out of your house if you have equity. It was practices like that that generated a lot of the mortgage mess in the first place. Pulling out equity to pay off other debt does not eliminate the debt, but rather just puts it out of sight. In most cases, when other debt is rolled into a house, the borrow then goes out and generates the same amount of debt again. You need a plan to get out of debt instead!