mortgage

Answers to 6 key refinance questions

Don Taylor
Highlights
  • Mortgage refinancing activity has surged in recent days as rates have plummeted.
  • No need to wait until rates drop by 2 percent before going ahead with refinance.
  • It sometimes pays to refinance so you can pay off an automobile loan.

Mortgage refinancing activity has surged in recent days as homebuyers rush to take advantage of suddenly plummeting loan rates.

The frenzy to find a new loan began when mortgage rates suddenly dropped in the wake of the Federal Reserve's Nov. 25 announcement that it will buy up to $500 billion of securitized loans.

The rate drop helped fuel a whopping 203.3 percent increase in refinancing activity for the week ending Nov. 28, according to the Mortgage Bankers Association.

To help homeowners make the right refinancing choices, Bankrate asked personal finance expert Dr. Don Taylor to answer some frequently asked questions about the process.


1. Does my new rate have to be at least 2 points lower? 
No. You don't have to wait until mortgage interest rates drop by 2 percent before you consider refinancing your mortgage.

The decision to refinance your home is dependent on many things, including how long you plan to be in the house, how much lower the interest rate will be on your new loan, the closing costs for the new loan, your equity position in the home and whether you plan to do a cash-out refinancing.

With a plain-vanilla refinancing, you're trying to take advantage of lower interest rates to lower your monthly payments. If you have enough equity in your home, you may even have a side benefit of being able to stop paying private mortgage insurance, more commonly known as PMI.

To take advantage of a lower rate you'll have to close on a new loan and pay the closing costs associated with that loan. That's true even if you opt for a no-cash or low-cash closing. With a no-cash or low-cash closing, the costs still are there, they just are paid for either with a higher interest rate or are included in the principal balance of the loan. (There's truly no such thing as a free lunch.)

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If you don't plan on being in the house very long, then the lower payments associated with the refinancing won't cover these closing costs. Bankrate's refinancing calculator will help you estimate your new mortgage payment, closing costs, and the months that it will take you to recoup those closing costs.

The table below shows an example of how the numbers work for someone with an existing 8 percent mortgage. It makes clear why you may not want to refinance for a rate only half a percent lower, but how reducing your rate by a full percent or more has a fairly short payback.

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