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Expert Q&A Archive

05/13/2008
Pros and cons of refinancing home mortgages.
When should someone consider refinancing a home mortgage loan, and when is it not a good idea? For instance, I have a home mortgage with a 6.75 % interest rate and want to refinance to get a 5.62% interest rate. I also want to get some equity out of it. What should I consider before making this decision?
Joan Koonce, Ph.D:
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Reducing your interest rate from 6.75% to 5.62% can save you a substantial amount of interest over a period of time. I did some calculations using both interest rates in a hypothetical situation, and the savings over a period of 30 years were great. If you refinance the same amount as you did initially on your current mortgage, your monthly payment will be less. A lower monthly payment may or may not be important to you. A lower interest rate is always good, but it needs to be substantial enough to justify refinancing. For example, there are usually upfront costs (closing costs) involved in refinancing, and if the change in the interest rate is small, then it may not be beneficial. In your case, the change in the interest rate is 1.13%, so refinancing is an option for you. Before taking equity out of your home, you should consider the reason for taking the equity. If you are using it to do home improvements or even buying a needed automobile, it
may be worth it. I would not do it to take a vacation or anything else that is not a necessity. Depending on the amount of equity you take out, your monthly payment could increase. If that is the case, you need to decide if you can afford a higher monthly mortgage payment. In addition, if you are taking equity to pay an unsecured debt (for example, credit card debt or other debt that is not secured with collateral), you might want to think twice about trading an unsecured debt for a secured debt, especially your home.
Lisa A. Arcangeli:
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If refinancing will lower your interest rate enough so that the monthly savings offsets the refinancing costs within a reasonable amount of time, that might be a good time to refinance. A reasonable amount of time depends on how long you think you will stay in your home. For
example if you owe $200,000 with a 25 year term at 6.75%, refinancing to 5.62% would save you $139/month. If it costs $2,000 to refinance it will take about 14 months to break even. Every payment after 14 months will save you $139/month. If you need money, refinancing may be a good way to get it depending on how much equity you have, what current rates are, how much money you need and for what. If market rates are the same as the rate you have on your mortgage and you can borrow the money at the same rate or a lower rate with a secured savings account, that would be the better option as it would save you refinancing costs.

Depends on what you are looking for. If you have a 30-year fixed and can reduce the rate by 1%, depending on how far into the loan you are, it is worth looking at. It usually costs 1% to refinance (closing costs, appraisals, etc.) If you can put money down and not have to pay PMI [private mortgage insurance] that
will help reduce your costs too. Always consider what you are trying to accomplish. How does your income work? If you make the same amount monthly or bi weekly, then a plain vanilla loan might be best, but if you work on commissions or have large bonuses where you can pay down lump sums at a time, then you may want to look at alternative loans. Remember, it costs money every time you refinance!
DeAnna Klokkenga CFP :
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One consideration to make is how long will you be in the house; if you plan to sell within 3 to 4 years you may not recoup the cost of refinancing.
Julie Ann Johnson:
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You must consider your entire financial picture when making any type of decision--how long you plan to stay in a home, how close you are to retirement, how much you have set aside for retirement, your cash flow, etc. etc. etc. A quality financial planner or advisor can help you with these questions
Claudia James:
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The considerations for refinancing are relevant to the individual's short-term and long-term objectives. Questions such as the following should be answered:

How long do I intend on staying in the house?

What are the associated closing costs? For a 30-year fixed rate you can determine how many months it will take to recover the closing cost by dividing the total closing costs by the monthly savings. Is it longer than you plan on staying in the house?

Will my income change during that period of time? Will it go up? Down? What kind of mortgage payment do I want in 5 years-10 years if my income changes?

What major home repair/maintenance needs do I anticipate? How will I pay for these? With the equity?

How healthy is my balance sheet? This affects the interest rate they'll offer you. You can get below market rates if the balance sheet is healthy.

Do I have an excellent credit rating? This affects the interest rate they'll offer you.

What is my risk tolerance? Tapping into the home equity can be risky. The home owner is, in effect, giving some or all of the equity to another party. Therefore they own less of their home. If the housing market drops, will I owe more on the house that what it is worth?
Sharon P. Hardy, CFE:
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I believe that some the major factors that must be taken into consideration in this decision is what are three current terms of the original mortgage (i.e. fixed or adjustable rate; years to maturity of the related promissory note, i.e., how long has the resident been in the home with regard to the original mortgage; how long do they plan to live in the residence if, in fact, they refinance). Of course there are other factors than those that I mention which also should be considered.

Still today, there are some home mortgages that, if paid off before maturity, the owner will incur prepaid penalties for doing so. Also, there are closing costs associated when refinancing your home. The ability to recoup such costs is largely dependent upon how long you intend to stay in the home after you've refinanced it.
Connie K. Marmet:
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Key criteria:
1.
What is the current value of your home? If you live in an area where prices have fallen significantly since you financed your home, it may be difficult to refinance. One way to get a high level indicator is to check recent sales of comparable homes in your neighborhood. If your home's value has declined, both refinancing and taking equity out will be difficult if not impossible. Hopefully you are in a neighborhood where this is not an issue but you need to be sure.

2. While refinancing charges are often partially waived, you need to check carefully what the costs
will be.

3. It's important to understand whether the new rate is fixed or if it's variable. If it's variable what all does that entail--what's the index, how often do rates increase, what's the monthly maximum increase, what's the highest rate that could occur over the life of the mortgage, are you being charged points to get the stated rate?
Elizabeth Rusnak:
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The general rule of thumb that I've used in the past is to only refinance when the rate will improve by at least 1%. You're right on the cusp of that 1%, so it might be worth looking into. The other thing to consider is how much will it cost to refinance. It's best to do a side-by-side comparison to see if it's worth it. As far as getting equity from the refinance, do so only if the new payment amount is one you can support. I don't recommend adjustable rate mortgages (ARM's). Most any mortgage loan can be refinanced (unless you have a substantial prepayment penalty). Generally, you don't need to have an adjustable rate mortgage to be considered for a refinance.
Jody Rorick, CPA:
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You should consider the closing costs and whether or not the decrease in rate, but the increase in the loan amount--since you would like to take out some of the equity--would result in payments you can afford. However, the climate being what it is today, the bank will be very careful to screen you and your ability to make the payments. It's not a good idea to refinance frequently because of the closing costs. You should consider the outlay of the closing costs compared to the savings resulting from the lower rate. Also, the longer you have your mortgage, the larger portion of each monthly payment will be applied to reducing the principal and less to interest, so that continually refinancing would mean you're paying down less principal
Bettye J. Banks:
expert info »
Any reduction in the interest rate over time can save you money. From 6.75% to 5.62% is significant. If you plan to be in the property for at least two years (sometimes less), it makes good sense to refinance. Consider the cost of refinancing and do the math.
Editor's Note:
During the March 31, 2008, Wi$e Up teleconference call, http://wiseupwomen.tamu.edu/teleconferences.php?date=2008-03-31 speaker Lourdes Tsukada, a mortgage banker with Flagstar Bank and Home Lending, stated that she usually advises people who are refinancing in order to reduce the interest rate, that the monthly savings on the principal and interest portion of the loan from refinancing should be $100 or more.