Close-up: Mortgage Refinancing

Physician's Money Digest, August 2006, Volume 13, Issue 8

n.

Mortgage Refinancing: Obtaining an extension and/or increase in theamount of existing debt, preferably at a lower, more attractive interest rate.

Mortgage refinancing is not a new practice. Itonly seems like it is due to the record number ofrefinances that occurred during the past 6 yearsor so. Diligent home buyers shop around for the best mortgagerate they can find, but because interest rates fluctuate,the most attractive rate 5 or 10 years ago might notbe the most advantageous today. And as interest ratesplummeted during the first several years of the new century,the number of homeowners refinancing their existingmortgages rose accordingly.

Does it always make sense to refinance? On the surface,saving $150 a month on your mortgage paymentmay seem like a sizable chunk of change—especiallywhen you figure that translates into $1800 a year.However, that's not the bottom line when determining ifrefinancing makes financial sense. There are many othervariables to consider when determining if it's the righttime to refinance your existing home mortgage.

Like Buying a New Home

The best way to think about refinancing your mortgageis to imagine that you're selling your existing home andpurchasing another. That's because the procedures you'llneed to go through and the costs you'll incur during a refinanceare almost identical to purchasing another home—only the moving costs are omitted.

The general rule of thumb when considering refinancingis that the potential new mortgage rate should be atleast 2 percentage points below your current interest rate.There are many other factors to consider as well.According to A Consumer's Guide to Mortgage Refinancings,one of the first questions you should ask yourselfis how long you intend to stay in your present home?If you're not going to remain in the home for at leastanother 3 years, you may not be saving any money in thelong run. That's because closing costs are incurred duringthe course of a refinancing. And according to the consumer'sguide, those closing costs can range from $1300to up to more than $2700—that doesn't even take intoaccount any points you might pay at closing. At the higherend, those dollars can easily surpass the annual savingsof a lower mortgage rate. Meaning, in order to come outahead on the cost of refinancing, you need to remain inthe home for a longer period of time.

Sometimes no matter how long you intend to remain inyour present home, refinancing will not make sense. Forexample, there are some families who have refinancedtheir mortgage every several years as interest rates continuedto fall, even though they may have already paid off 10years of a 30-year mortgage. By refinancing for another30-year mortgage, they're now making mortgage paymentsfor 40 years vs the original 30. It can be difficult torealize any savings under those circumstances.

When It Makes Sense

There are several key conditions under which refinancingcan be a good idea, according to the consumer's guide. Oneof these circumstances is if your existing mortgage is anadjustable rate mortgage (ARM), and you'd prefer to refinanceto a fixed-rate loan. Given howinterest rates fluctuate, you mayprefer a set payment for the lifeof the loan.

Another factor would be if youhave an existing ARM and want toconvert to one with a lower interestrate and more protective features, suchas a better rate and payment caps.Keep in mind, of course, that interestrates, although they have been inching upin the past year, can always go back down. If youlock into a particular rate because it's attractive today, itmight not be as attractive a few years from now.

If you're considering refinancing yourmortgage, one key cost-saving step that theguide suggests is to first check with thelender who holds your current mortgage. Inorder to keep your business, the lendermight be willing to waive some of the costsof a refinance in order to retain a satisfied customer.Remember that lenders want your businessas much as you want the best mortgage tomeet your financial situation.

Avoid CommonRefinancing Mistakes

If you're considering refinancing your existingmortgage, remember to do the same homeworkyou would if you were applying for a mortgage onyour first home. After all, you're refinancing to savemoney on your monthly mortgage payments, notpay more. According to Refinance.com, the followingare several key refinancing mistakes to avoid:

•There are many ways to refinance a loan. Justas with an original mortgage, there are fixed-rate,adjustable rate, and hybrid loans. Compare themand don't settle.

•You want your refinance to make financialsense, so be sure to conduct a breakeven analysis.How long will you stay in the home, and howlong will it take to begin to realize savings?Refinance.com offers free calculators to help youanswer those questions.

•Statistics show that when most people considerrefinancing, they first think of a fixed-ratemortgage. However, in some cases, adjustable-ratemortgages might be the way to go. Talk to afinancial advisor, or check the calculators atRefinance.com to make the comparison.

•Don't pay too much for mortgage insuranceor private mortgage insurance (PMI). Refinance.compoints out that if you refinance with less than an80% equity stake in your home, you could end uppaying too much for PMI, and that can add a lot toyour monthly mortgage payment.

POP QUIZ

1) How many percentage points lower should a refinancedmortgage be?

  1. 1
  2. 2
  3. 3
  4. 4

2) If you refinance, you should remain in your existinghome for how many years?

  1. 1
  2. 2
  3. 3
  4. 4

3) Refinance closing costs can run as high as

  1. $1200
  2. $2000
  3. $2700
  4. $3500

4) Fixed-rate mortgages are better than adjustable-ratemortgages for refinance purposes. True or False?

  1. True
  2. False

5) To avoid a hefty mortgage insurance payment, howmuch equity should you have in your home beforerefinancing?

  1. At least 50%
  2. At least 60%
  3. At least 70%
  4. At least 80%

Answers: 1) b; 2) c; 3) c; 4) b; 5) d.