Is It in Your Best Interest?
Before You Join the Flock Trying to Refinance, Determine If a New Loan's Terms Fit Your Goals
Saturday, January 31, 2009; Page F01
On its face, deciding whether it's worth it to refinance your mortgage seems simple enough.
Shop for the lowest rate possible. Figure out what your monthly payment would be at that new rate. Compare it with what you're paying now and decide whether the savings (assuming there are any) offset the closing costs of the loan quickly enough.
But as with most money matters, nothing is that simple. Refinance applications have soared in recent weeks as interest rates hit record lows. The rush has slowed somewhat as rates have leveled off, but it may pick up again now that the Federal Reserve this week has renewed its commitment to try to push down consumer interest rates. While the gyrations in the credit market have made it tough for many people to take out a loan for a new home, it's less of a hassle to refinance, especially for owners with good credit who have built up equity over time.
If you're contemplating joining in, think about what you are trying to achieve by refinancing and how best to do so.
"It's not a one-size-fits-all type of thing. It's barely a one-size-fits-most," said Keith Gumbinger, a vice president at mortgage research firm HSH Associates. "You have to have a goal in mind."
Are you refinancing to save money by minimizing the total interest expense during the life of the loan, or are you trying to free up cash by lowering your monthly payment?
Are you rushing to pay off your loan as quickly as possible and, if so, are you short-changing your cash needs in the process or eating into your emergency fund?
Maybe you're eager to ditch an adjustable-rate mortgage before it resets, switching to a more predictable fixed-rate loan, as many consumer advocates advise. But have you considered that your loan may reset to a lower rate if it is tied to a Treasury index? Can you stomach holding on to it longer? Should you?
Answers to many of these questions are a function of timing.
Let's assume you live in Maryland and took out a new loan that saves you $50 a month. The average closing costs in that state last year were $3,117 on a $200,000 loan, according to Bankrate.com, a personal finance Web site that compiles an annual closing cost overview. It would take a little more than five years to break even on that loan. The goal is to get beyond the break-even point.
"If you're planning to sell the house within that period, it doesn't make sense to refinance," said Ric Edelman, a financial adviser in Fairfax. "But if you're planning to stay for 10 more years, it does make sense."
The same reasoning goes into deciding whether to pay points, which are the upfront fees borrowers pay to reduce the rate on the loan. A point is 1 percent of the loan amount.