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Time to Refinance - Again?

By Robert E. Sternberg, CPA

Mortgage rates are constantly fluctuating. At the time of the writing of this article, mortgage rates are at historical lows. Depending on your current interest rate and other terms of your mortgage, you may have the opportunity to save significant money and improve your monthly cash flow. You may also have the opportunity to consolidate credit card debt and other costly financing.

If you have a mortgage or any debt outstanding, it always makes sense to see if there are opportunities to save money. The following are important questions to ask:

Let's examine the bullet points above a bit more closely.

What is the current interest rate and balance on your mortgage?

It may seem obvious if you know your current interest rate and your mortgage balance. If you're not sure, take a look. If you have on-line access just log on, or call lender and ask. Bear in mind that the higher the mortgage balance or interest rate, the greater the potential savings. Since the interest portion of your mortgage payment is computed by multiplying the interest rate by the mortgage balance, a larger mortgage balance will typically yield larger potential savings. This can hold true with even a minor drop in the interest rate. To get an idea of current mortgage interest rates just go to the internet and do a search such as "current mortgage rates". With this information you can shop around. The best place to start is with your current lender. Your current lender may have streamlined application procedures for existing customers as well as reduced costs.

Refinancing costs

Costs are an important factor in deciding to refinance. In order for a refinance to make sense, your total savings from reduced payments need to be greater than the costs to refinance. For example, if the costs to refinance are $2,400 and the monthly saving are $100 then it would take 24 months for refinancing to make sense. Unfortunately the calculation is almost always a bit more complex than that.

How to determine savings

Determining monthly savings can be complicated. You usually can't just subtract the new payment from the old payment to determine your monthly savings. The remaining number of payments will almost never be the same on the two mortgages. For example, let's say you are three years into a 30 year mortgage. That means you have 27 years remaining (or 324 monthly payments). If you refinance with a new 30 year mortgage, you will be making the new payment for 30 years (or 360 monthly payments). Since you will be making 36 more payments to pay off the same mortgage balance, a reduction in the monthly payment does not necessarily translate into savings. Conversely, if that mortgage, with 27 years remaining were refinanced to 15 years, the monthly payment would almost always increase, but there is still a potential for significant savings.

Additionally, in calculating costs to refinance, you need to disregard any refunds or outlays for escrow funds as these are not true costs. Many times, lenders add the costs to you mortgage balance so that you don't pay them separately. Either way they are still costs and you are paying for them, and they should be considered.

Debt consolidation

Many times people will refinance to pay off other more costly or expensive debit. While this may yield significant economic and tax benefits, it can also be quite dangerous. If you can't pay your mortgage, you could lose your home. Additionally, if you use the equity in your home to pay off existing debt, and have a need for money in the future, you may not be able to get the funds when your house is fully leveraged. Proceed with caution and consider seeking professional advice before using home equity for paying off other debt.

Fixed vs variable interest rates

Mortgages either have a fixed or variable interest rate. The most common fixed rate mortgages have terms of 30 or 15 years. Typically, the shorter the term the lower the interest rate. At the time of the writing of this article, most 15 year rates were approximately .75% lower than 30 year rates. Historically the spread has ranged from .25 to .75%. If your financial condition has improved, it may make sense to go for a shorter term. It may cost more per month, but in the long run could make a lot of sense and save you significant money. In some instances a variable rate mortgage may make sense, especially if you don't plan on holding the mortgage for very long.

Credit status

The final consideration is how good or bad your credit is. Having bad credit can result in your application being turned down or cause you to be charged a higher interest rate. If you are unsure of your credit rating, it may make sense to get a free credit report. This will enable you to find out if there are any erroneous or outdated credit problems that you may be able to resolve before applying for a mortgage. In fact, it's probably a good idea to do this anyway, regardless if you plan to apply for a mortgage.

In summary, in the right situation, refinancing your mortgage is one of the easiest ways for you to save significant money without taking any risk. The key is being able to accurately determine the potential savings, if any, as well as choosing the correct type of mortgage for your situation.

I have successfully advised my clients for over 25 years when making refinance decisions. Please contact me if I can be of any help when considering refinancing your mortgage.

Posted: August 2012

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