Historically low interest rates have many people tempted to repeatedly refinance their mortgage. Before you turn into an interest rate-chasing junkie, let’s talk about when refinancing makes sense and when it can cost too much. First, keep in mind that refinancing merely restructures your existing debt; it doesn’t make it go away. When thinking of refinancing, be clear about your goal
Are you looking for a short-term solution, such as:
1) Getting out of an adjustable-rate mortgage (ARM) or an interest-only loan.
2) Removing your soon to be ex spouse from the mortgage loan because of divorce.
3) Tapping into your home’s equity for cash to pay off higher rates of interest debts such as Credit Cards.
4) Been in your home for a little while now and want to refinance to remove PMI payments from your monthly mortgage.
5) Want a lower monthly payment.
6) Just want to pull out some extra cash that you have built up into your home due to it appreciating.
Know your total cost. Unless you are forced into refinancing to fulfill your divorce settlement agreement, repeatedly refinancing just to score the latest low interest rate might not be worth the extra cost. Hefty closing costs manifest themselves in unexpected places and forms. They can be disguised in origination points, a higher interest rate or a higher loan amount. And, if your loan amount exceeds 80 percent of your home’s appraised value, then there are other expenses, such as private mortgage insurance.
Consider how many months of lower payments it will take to recoup the closing costs of the new mortgage. A lower interest rate decreases your monthly payments but also extends the mortgage term, which means spending more in interest over time. So make sure that you plan to stay in your home or a while.
Before making a move toward refinancing, be sure to shop around. Before 2010, you almost needed a master’s degree in finance to interpret lender fees. Fortunately, these days it’s easier to compare rates and fees. In 2010, the U.S. Department of Housing and Urban Development (HUD) ruled that all mortgage lenders are required to report the fees the same way using a standardized form. So make sure to compare numbers from at least three lenders. To help you crunch the numbers and figure out your total cost, use a refinancing calculator; there are several online sites with calculators to help you.
In some cases, a mortgage refinance makes sense. If you plan to stay in your home for a while, have a solid credit score and the savings from refinancing outweigh the total cost, it’s definitely the way to go. Sometimes, refinancing into lower monthly payments – despite higher costs in the long run – is the only solution to allow you to stay in your home.
In other cases, you will be better off sticking with your current mortgage. For example, if you just need to get out of an ARM, the high cost of a refi may not be warranted if you don’t plan on staying in the house long term. After all, have you ever run the numbers to determine if you could support the payments when your rate resets? It may not be as bad as you think. Or if your mortgage is almost paid for, it may not make sense to start all over again.
Most importantly, have a plan in place for the extra cash you will be able to free up after you refinance. Instead of letting giddy exuberance lead you to fritter it away, employ a modicum of prudence and put it to good use.