Wrestle with the Decision to Refinance

Physician's Money Digest, August15 2004, Volume 11, Issue 15

With mortgage rates at record lows, nowis an excellent time for doctors to refinance a high-rate mortgage. By doingso, you can lower your monthly paymentsor reduce the time it will take to pay off yourloan. But before you make any decisions, be sure thatthe mortgage rate cut is large enough to warrant arefinancing. You also need to carefully consider all thecosts involved in refinancing.

Calculating Your Decision

An online article at Fool.com advises against usinga simple rule of thumb to guide your decision to refinance. For instance, homeowners are commonly toldto look for a minimum interest rate improvement ofabout 2 percentage points from their existing mortgagebefore they seriously think about refinancing.However, this type of approach can be misleading.

According to the article, the interest rate cutrequired in order to come out ahead will vary dramaticallydepending on how long you plan to hold thenew mortgage, how many years you've already paidon the current mortgage, and available opportunitiesfor cutting closing costs.

How can you be sure that refinancing is right foryou? You can use the Fool.com's online calculator"What will my refinancing costs be?" Simply take thespecific numbers that match your particular situation—such as how much remains on your currentloan and what rate you're currently paying—andenter them into the calculator. The online calculatorcan also be used as a guide for reviewing potentiallenders. Enter the data you receive from lenders intothe calculator to get expected closing costs.

To find out how much you'll save in mortgageinterest payments after refinancing, use the Fool.com'ssecond online calculator "Am I better off refinancing?"If you worked through the closing cost calculatorfirst, you'll find that much of the required informationfor this second calculator will be handy.

Refinancing to Reinvest

Does it pay to use the money from refinancing for aninvestment? An article in the Express-Times suggeststhat while some financial experts have long advocatedthis idea, it may not make sense in today's unstablestock market. For instance, if you had taken $50,000out of your house a year ago and invested it in a stockfund that mirrored the broad market, you would be leftwith only $36,500 today. In addition, you would still bemaking payments on the $50,000 loan.

Investing in long-term bonds is also too risky rightnow. That's because with bond yields being so low, theyare more likely to rise than they are to fall. For example,if you put $50,000 into 10-year US Treasury bonds,you'd earn about 3.6%, or $1800 a year. Assuming youraised the $50,000 with a 4.9% 15-year mortgage, thefirst year's interest charges would total approximately$2400. Thus, you would pay $600 more on the debtthan you would earn in interest. That's not a big priceto keep that $50,000 in reserve.

However, if interest rates on new bonds rose by acouple of percentage points, no one would pay$50,000 for your old bonds. You probably wouldn'tget more than about $40,000. A safer alternativewould be to use the $50,000 to buy a 5-year CD. TopCDs pay about 4%. You would earn about $2000 ayear, allowing you to pay all but $400 of your interestcharges on the $50,000 mortgage. And the risk of losingprincipal would be eliminated.

You could always redeem the CD early, if later onyou saw a better investment opportunity. The earlywithdrawal penalty for CDs is usually equal to the last6 months' interest earnings. However, that $1000 losscould be easily recouped if new CDs were paying 5% or6% at that time. Just be certain to find out how muchthe penalty is before investing.