When Should You Refinance Your Mortgage?
Published On September 4th, 2012

Interest rates on home loans are extremely low, but does that mean you should refinance? At what point should you do it? It's not always obvious because getting a new loan isn't free. There are costs that must be absorbed by the homeowner.

You need to consider the change in interest rates, the length of the loan, and the closing costs. It's simple math after that.

These are the basic factors to consider:

1. How much have rates dropped vs. your current loan? Keep in mind that if you borrowed $750,000, a one percent decrease in the interest rate is likely to mean more than if you only borrowed $40,000. Look at the change in your payments and calculate how much you will save long-term.

2. How long is the loan term? If you only have five years left on your mortgage, then it won't matter as much as if you have 27 years left. It's possible you might lose money in the first case and make out extremely well in the second. Again, look at how much you will save each month vs. the expense of obtaining the new loan.

3. Could you handle a shorter term now? Consider that you might be able to handle a shorter period of time now. If you can reduce your current loan from 23 years to 15 years, there might be a lot of savings there. Even if your monthly payment doesn't decrease, you could still save a lot by making payments for 8 years less.

4. What are the closing or acquisition costs? The banks charge you to borrow their money, and we're not talking about just interest. There are fees for credit checks, appraisals, origination fees, and much more in a mortgage refinance. Find out these costs from your lender and include them in your evaluation process. There is a document the lender must give you called a "Good Faith Estimate" which will outline these costs in detail.

5. Are you going to achieve any other goals besides lowering your interest rate?  Properly structured refinances may allow you the opportunity to "cash-out" for home improvements or other needs, or in certain circumstances, pay off/consolidate high interest debts into a low tax-deductable mortgage debt.  Consult your mortgage advisor for details on these more advanced refinancing strategies.

The key is to compare your current loan and associated payments to the new loan's payments and the costs to acquire that loan. Remember to include the length of the loan in your calculations.

Some Cautions:

1. Closing costs: Some banks have outrageous closing costs on refinance loans. Be sure to shop around before you borrow the money. Banks can vary dramatically on closing costs.

2. Be cautious about getting a longer term. Some people get excited at the prospect of stretching out the loan to get even lower monthly payments. The equity in your house is going to build much slower. A smaller monthly payment isn't necessarily a savings if you have to make a lot more of them.

3. Experience: Make sure you are working with a mortgage advisor who you are comfortable with and who has several years of experience.  A professional mortgage planner will explain all of the options to you in detail, and help guide you to the best loan for your needs.  These types of professionals can also advise you on the possibility of restructuring non-tax deductable debt and the options you may have to use your mortgage as a financial tool to achieve your long term as well as short term goals.

Now you have some idea on how to evaluate your situation to determine if it would benefit you to refinance your mortgage.Reducing your expenses is a significant part of improving your financial circumstances. Paying less interest for your mortgage loan could save you many thousands of dollars. The only way you can tell is to do the comparison. So pull out your calculator and run those numbers. You might be very pleasantly surprised!

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