refinance

What to know before refinancing

Highlights
  • Refinancing makes sense if you have an ARM or want to lower payments.
  • To determine if you will save money, calculate your break-even point.
  • Shop for a loan within 30 days so as not to ding your credit score.

The Federal Reserve's decision to buy up mortgaged-backed securities caused mortgage rates to fall and created new opportunities. Should you refinance your mortgage now? Before you rush to refi, take a few minutes to determine if it's the right move for you.

When does it make sense to refinance?

Refinancing involves starting over and applying for a new loan. Whether homeowners deal with the original lender or a new one, the new loan will pay off the old loan and the borrower then makes payments according to new loan terms.

Good reasons to refinance include getting a lower interest rate, shortening the term of the mortgage to build equity faster, lowering monthly payments or switching from an adjustable rate to a fixed-rate mortgage.

Even if you just secured a new mortgage very recently, it might make sense to refinance. Homeowners should consider refinancing if, in the long run, it will save them money.

First you have to find out the cost of getting the new loan. Refinancing can cost around 2 to 3 percent of the total loan amount.

To determine if it will save you money, calculate your break-even point. You can calculate it by dividing the mortgage fees by the monthly savings. The answer you get tells you how many months it will take for you to break even.

Calculate your break-even point
Monthly savings from refinancing:$100 a month
Closing costs:$3,000
Break-even point:30 months

If you plan on retiring in the house, strongly consider refinancing. If you plan to sell within two and a half years, it may be unwise to refinance.

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How do you figure your monthly savings? You'll have to get an estimate of the rate for which you'll qualify. A mortgage broker or loan officer can tell you that. Ask the loan officer, or consult a mortgage calculator, to determine what your principal and interest payment would be with the new loan. Don't compare that with your current mortgage payment, which likely includes a pro rata share of your property tax and insurance payments. Your payment coupon should show an itemization of your current monthly principal and interest payments. Now you can figure out how much you would save every month.

Find out if your current loan has a prepayment penalty. If it does, determine what the penalty would be if you refinance, and add that amount to your closing costs to determine your new break-even point. It might make sense to hold off on refinancing until you're clear of the prepayment penalty period.

What if you owe more than your house is worth?

For homeowners upside down on their mortgages, refinancing probably won't be in the cards. Try to look at it from the lender's viewpoint.

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