Should I refinance?
The most common reason for refinancing is to save money.
Saving money through refinancing can be achieved in two ways:
- By obtaining a lower interest rate that causes one's monthly mortgage
payment to be reduced.
- By reducing the term of the loan, thus saving money over the life
of the loan. For example, refinancing from a 30-year loan to a 15-year
loan might result in higher monthly payments, but the total of the
payments made during the life of the loan can be reduced significantly.
People also refinance to convert their adjustable loan
to a fixed loan. The main reason behind this type of refinance is
to obtain the stability and the security of a fixed loan. Fixed loans
are very popular when interest rates are low, whereas adjustable loans
tend to be more popular when rates are higher. When rates are low, homeowners
refinance to lock in low rates. When rates are high, homeowners prefer
adjustable loans to obtain lower payments.
A third reason why homeowners refinance is to consolidate
debts and replace high-interest loans with a low-rate mortgage. The loans
being consolidated may include second mortgages, credit lines, student
loans, credit cards, etc. In many cases, debt consolidation results in
tax savings, since consumers loans are not tax deductible, while a mortgage
loan is tax deductible.
The answer to the question "Should I refinance?"
is a complex one, since every situation is different and no two homeowners
are in the exact same situation. Even the conventional wisdom of refinancing
only when you can save 2% on your mortgage is not really true. If you
are refinancing to save money on your monthly payments, the following
calculation is more appropriate than the rule of 2%:
- Calculate the total cost of the refinance––example: $2,000
- Calculate the monthly savings––example: $100/month
- Divide the result in 1 by the result in 2––in this case
2000/100 = 20 months. This shows the break-even time. If you plan
to live in the house for longer than this period of time, it makes
sense to refinance.
Sometimes, you do not have a choice––you are forced
to refinance. This happens when you have a loan with a balloon provision,
but with no conversion option. In this case it is best to refinance a
few months before the balloon comes due.
Whatever you choose to do, consulting with a seasoned mortgage
professional can often save you time and money. Make a few phone calls,
check out a few web sites, crunch on a few calculators and spend some
time to understand the options available to you.
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