Make Sure a Refi Adds Up

By Mary Ellen Slayter
Washington Post Staff Writer
Sunday, February 3, 2008

Recent dips in interest rates may have homeowners wondering whether it's time to refinance their mortgages.

Refinancing can make sense for many people, but the decision should take into account more than swings in market interest rates, consumer-finance experts say.

"It is a lot more complicated than it used to be," said Holden Lewis,'s senior reporter specializing in mortgages. Until recently, he said, people refinanced for three main reasons: to get a lower rate, to get rid of private mortgage insurance premiums, or to pull out cash to consolidate bills or pay for big-ticket expenses.

Now, he said, owners are frequently motivated by a fourth reason: changing the type of loan they have. Perhaps their adjustable-rate mortgages are scheduled to reset soon, and they are worried that their interest rates and payments are going to rise. In other cases, they are worried about ARM resets that are years away, thinking that a decline in their houses' value could keep them from being able to refinance then.

"I think it's a real fear out there," Lewis said. "People are in risk-management mode, instead of just simple math mode."

That math is indeed pretty simple, but the calculation must be made specifically for your mortgage, said Ted Toal, a certified financial planner with Triton Wealth Management in Annapolis. "Just because rates have dropped, don't feel pressure like you have to refinance," Toal said. "Take a look at your current loan, do the math and see if it makes sense."

The math starts with the interest rate on your current loan, Toal said. Is the rate on your current loan higher than what you would qualify for today?

Toal said many people who bought or refinanced three to four years ago already have "very good rates," but that those who bought in the past year or two might benefit from refinancing.

Keep in mind that individual factors, such as income, credit scores and equity, will also influence the rates for which a person qualifies. That could benefit homeowners whose circumstances have significantly improved since they took out their current loans, but it could be an obstacle to refinancing for those who are struggling.

A prospective refinancer will also find that rates vary depending on how much they borrow and over what term. For example, a 15-year mortgage generally comes with a lower interest rate than a 30-year one. The monthly payment may be bigger, but the savings over the life of the loan can be significant.

The next factor to consider is whether there are any upfront closing costs, such as origination fees and points. Those can vary significantly among loans; many lenders offer no-cost refinancing, in which fees are rolled into the interest rate.

Toal said borrowers should be cautious about adding closing costs to a loan balance. "It's better to pay the closing costs out of your own pocket rather than rolling them up into the loan," he said. "Financing that expense over 30 years with interest is not a good idea."

Next, look closely at the paperwork for your current loan and see if you will owe a prepayment penalty if you pay that loan off early.

Once you know how much the refinancing would cost you out of pocket and how much you would save monthly with the new interest rate, use those two numbers to determine the break-even point -- the date that the monthly savings equal the costs associated with refinancing, Toal said.

What's a reasonable length of wait for that break-even point? Stuart McHenry, a certified financial planner with Open Heart Financial in Waldorf, said it depends on how long a person intends to keep the mortgage. Two years is his general guideline for breaking even. "And if a person can recoup the costs instantly by doing a no-cost refi, then that's obviously attractive," he said.

McHenry said homeowners with ARMs shouldn't automatically assume that they would benefit from a fixed-rate loan. If they are planning to sell in a few years, for example, another ARM may make more sense than a fixed-rate loan. There's little advantage to taking a fixed-rate loan, at a higher rate, if the borrower is going to sell before the ARM adjusts, he said. "You're spending money on interest rate insurance that's unnecessary."

But for those whose loans make them anxious, the recent drop in rates "can be a great opportunity to refinance out of an unstable ARM," said Kimberly Lankford, a personal finance columnist for Kiplinger's magazine and author of "Rescue Your Financial Life" (McGraw-Hill, 2003).

She suggested that borrowers with ARMs look beyond the rates they pay now to what they could pay at their next adjustment. In that case, they may even find a small increase in the short term is worth it. "This can really give you some stability for years in the future," she said.

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