refinance

What to know before you refinance

Mortgage insurance

Nationwide drops in home values may present a challenge for homeowners who want to refinance because a higher loan-to-value ratio can trigger the need for mortgage insurance. This issue "is killing a lot of the enthusiasm" to refinance, Metzler says. If you'd like to refinance but are short on equity, you should still do the math because your mortgage insurance payments may be tax-deductible and could be eliminated if your equity increased in the future.

Discount points

A similar break-even analysis can help you decide whether to pay discount points to buy down (i.e., reduce) the interest rate on your new mortgage. Here's an example that assumes a half-point discount on the interest rate for a payment of one point, which is equal to 1 percent of the loan amount:

Example: Calculate break-even analysis

Loan amount:$250,000
Term:30 years
Payment at 5.5 percent:$1,419.47
Cost of one point:$2,500
Payment at 5 percent:$1,342.05
Monthly savings:$77.42
Break-even point:33 months
($2,500 divided by $77.42)

Keep in mind that if you add the point (or points) to your loan balance, your new payment will be higher than it would be if you paid the point upfront in cash.

Debt consolidation

Homeowners who want to tap equity to pay off other debts, remodel their home or make other purchases face a more complicated decision to refinance, in part because other debts or options such as a home equity line of credit will involve various rates and terms. Debt consolidation may make sense if the refinance would strengthen your overall financial situation and you're disciplined enough not to run up more debts. Debt consolidation can "improve your household cash flow dramatically," Thorne says, and that's an important goal for some homeowners today.

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