When is it Time to Refinance?
We debated last year over the timing to refinance our home. Funny because as a real estate agent you might think I would know the magic time to do this. So after a lot of thought, calls to lenders, and a hand written list of pros and cons we finally did it and boy are we happy with the monthly savings. Like anything else, refinancing has its good points and bad. First of all, trying to predict the best time to refinance is like trying to predict a teenager’s moods — impossible and slightly dangerous. But there are some gauges you can use to decide if refinancing makes sense for you.
There are myriad motives for refinancing your home mortgage, but the most common reasons to refinance are to lower your interest rate thereby lowering your monthly payment; to reduce the length of your mortgage to save thousands of dollars in interest; to use your equity for home improvements or other large expenses; when interest rates are low, to lock in a constant interest rate if you have an adjustable rate mortgage (ARM); when rates are high, to convert to an ARM to lower monthly payments; if your mortgage has a balloon provision with no conversion option; and/or for debt consolidation.
Refinancing for debt consolidation can be tricky. The loans being consolidated may include second mortgages, credit lines, student loans, credit cards. In many of these cases, debt consolidation also carries with it tax savings, since mortgage interest is tax deductible and consumer interest is not. Later, we will look at a case of debt consolidation through refinancing gone wrong.
While all the above refinancing reasons are legitimate and reasonable, there are many factors to consider. For instance, it will be identical to the process you underwent when securing your original mortgage — requiring an application, credit check, title search, etc. This process, as you already know, is time-consuming and often expensive. Refinancing is not free. There are bank fees, appraisal and inspection fees, lawyer’s fees, points and closing costs, just like the first time around.
Calculating Your Savings
So how do you calculate what rate you need for refinancing to be worthwhile? The interest rate isn’t the only thing to consider when shopping for a new loan. However, the general rule of thumb is that if you can get an interest rate at least two percentage points lower than what you are currently paying, refinancing will pay for itself.
Pull out a piece of paper and figure out:
1) your current monthly payment,
2) the original cost of the home;
3) an Itemization of refinancing costs,
4) your monthly payment after the refinance,
5) the length of time you plan to live in the house after the refinance,
6) the amount still owed on the house, and
7) the break-even point (calculate this by dividing the total cost of the refinance by how much you’ll save each month on your payment; for example: $2000 cost of refinance divided by $100 per month savings equals 20 months).
Depending on your ultimate goal in refinancing, the above numbers should give you a good idea of whether or not it makes sense. If it still looks like a jumble to you, there are many online “calculators” that can assist you in figuring out the pros and cons of refinancing: www.reficenter.com and www.smartmoney.com for example.
If you want to refinance, it’s a good idea to think and plan carefully before you do so.
First rule: if you plan to pull out cash from your refinance to pay off credit card debt, close your credit card accounts (don’t just cut up the cards) so you don’t run them up again.
If you’re pulling out cash to make home improvements, do them right away. It is very easy to fritter money away without realizing it, and to adjust to a higher standard of living — even a temporary one.
If you’re pulling out cash for any reason, consider not pulling out the maximum. Leave some equity in place for your security, to ensure a lower house payment, or in case of emergency.
Refinancing can be a boon — or a bust. It’s up to you to do the homework and decide if it makes sense for you.