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The four rules when considering refinancing

By Ilyce R. Glink and and Samuel J. Tamkin,

I owe $86,717 on my mortgage, which is a 30-year fixed-rate loan with an interest rate of 5.25 percent. I received a flyer in the mail from a company offering me an interest rate of 3.99 percent, but it would increase my loan to $87,475, an increase of $758.

I now pay $703 a month for my mortgage, insurance and taxes. If I refinance, my payment would drop to $625 per month for another 30-year fixed-rate loan.

Do you think it’s worth it for me to refinance? Being single, with only my income, I can certainly use the extra cash. And, by the way, the only thing they say I have to bring to the table is $170. I think it’s the equivalent of two months of interest. What do you think? Should I do this deal?

We have four rules for a home run refinance. Ask yourself these four questions:

Can you lower the interest rate on your mortgage? Can you lower your monthly payment? Can you shorten the loan term? And can you pay off the costs of the refinance in a year or less from the monthly savings?

If you answer “yes” to each of these questions, then refinancing is a home run proposition for you.

But in your case, as with many others who are considering a refinance, your answers aren’t going to be uniform.

First, while you would lower the interest rate and your payments with this offer, you’d be going with another 30-year loan term. Although I don’t know how long you’ve had your current loan, starting with another 30-year term means that overall you’re likely to be paying more interest, or at least a lot more than if you chose a shorter loan term.

For example, you could amortize your loan so that you pay it off in the same number of years you currently have left. If your current loan has 25 years left, you should compare the payment you’ve been making with whatever your new payment will be if you pay off the loan in the same number of years. That will tell you how much you are truly saving.

A yellow flag is that the lender is clearly folding your closing costs into the total amount of the loan. The amount is only $758, or less than 1 percent of the loan amount (and a good deal, by the way), but you’re still going to pay interest on that amount for a long time to come.

As you say, saving $75 per month is nothing to sneeze at, especially if you’re making it on one income. And if $75 is an important factor for you, then it doesn’t matter if you’re paying an extra five years’ worth of payments.

We just want to be certain you understand the trade-offs you’re assuming for that $75.

And to be clear: Just because your refinance offer doesn’t match up with my four rules doesn’t mean it’s not worthwhile. According to the latest reports, a full one-third of all homeowners refinancing are doing so under the Home Affordable Refinance Program because they don’t have enough equity in their homes to refinance otherwise.

While you can shop around for a HARP refinance, these programs will be more expensive and less generous than if you have at least 20 percent equity in your property. They probably won’t match up with our home run refinance rules, but they can be quite helpful all the same.

Ilyce R. Glink’s latest book is “Buy, Close, Move In!” Samuel J. Tamkin is a Chicago-based real estate attorney. If you have questions, you can call Ilyce’s radio show toll-free (800-972-8255) from 11 a.m. to 1 p.m. any Sunday. Contact Ilyce and Sam through her Web site, www.thinkglink.com.

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