Your Retirement Center
Refinancing
When interest rates go down, you may want to refinance your mortgage to get a lower rate.
homesThough some mortgages do turn out to be the lifetime commitment they seem to be when you're in the middle of a closing, you may choose to refinance, or arrange for a new mortgage at a lower rate or for a different term. With the new money you borrow, you pay off the original mortgage.

Because interest rates change constantly, what seems like a good rate at the time you buy may be much higher than typical rates just a few years later. Refinancing can bring your housing expenses more in line with what other people are paying.

Refinancing doesn't come cheaply, though. You often have to pay up-front fees and closing costs again, even if your mortgage is only a few years old. That's especially true when you switch lenders.


WHY REFINANCE?You may want to refinance your mortgage for several reasons:

  • You can borrow at a lower interest rate, which will reduce your monthly payments and often the overall cost of the mortgage

  • You may want to consolidate outstanding debt — for example, by combining a first and second mortgage into a single new one

  • You may want to reduce the term of your loan, which while it may increase your monthly payment, will dramatically reduce your total cost

The traditional rule of thumb is that it pays to refinance if you can get an interest rate at least TWO PERCENTAGE POINTS lower than you're currently paying. More recently the trend has been to refinance for just a ONE PERCENTAGE POINT reduction. The deciding factor is whether refinancing will save you money.

But every situation is different. To figure out whether you can save money by refinancing you need to consider:

  • How much lower your monthly payments will be

  • What refinancing costs you must pay

  • How long you plan to stay in your home

  • How many years remain on your current mortgage

Your best bet is to tell the lender what you paid for the house, what you still owe, and how much you're paying each month. Have the lender itemize all the up-front expenses involved in the refinance and estimate your new payments. Then you can figure when you will break even and start saving.

For example, if you save $1,600 in mortgage payments each year by refinancing, but it costs you $4,800 to refinance, you'll have to stay put more than three years to realize any savings.

OTHER CONSIDERATIONS If you've been paying your present mortgage for a number of years, deciding whether or not to refinance is a little more complicated. That's because you may have paid off a substantial part of the interest you owe on the loan and begun to chip away at the principal. When you refinance — which means you're taking a new loan — the bulk of your monthly payment once again goes toward interest.

A potential lender or real estate attorney should be able to help you compare the combined total interest you'd owe if you refinanced with the amount remaining on your existing mortgage. You can also use one of the refinancing calculators you can find on most bank and financial services company websites.

 
When Does It Pay to Refinance?
People who refinance their mortgages should be planning to stay in their homes at least long enough to recover the costs. This worksheet can help estimate how long it will take before refinancing begins paying off. (The example shows the estimated payback period for refinancing a $100,000 mortgage if an existing loan at 8.5% is replaced with an 6.5% loan. Amounts shown are examples, and will vary by bank and by area.)

Itemized Costs of Refinancing Yours Example
Discount points $_____ $2,000

*Principal and interest only

 
WEIGHING YOUR CHOICES You can arrange refinancing to switch from a fixed-rate loan to a loan with a lower rate, from an adjustable-rate loan to a fixed-rate (something that may be attractive if rates seem headed up), or from a fixed-rate loan to one of the hybrid adjustables, such as a 10-year fixed/20-year adjustable loan.

If you sometimes feel you're a slave to your mortgage, consider the ancient Romans. They did become slaves if they defaulted on a mortgage — at least before 326 B.C.
Refinancing moves in predictable patterns. A big drop in rates in the economy at large or the introduction of a new strain of loans provokes a flurry of activity, generally followed by a period of calm. Then the cycle may begin again.

WHAT IF YOU FALL BEHIND IN YOUR MORTGAGE PAYMENTS? Although lenders can foreclose your mortgage and begin the process of repossessing your home if you're 90 days behind in your payments, most will agree to less drastic measures. Some possible solutions:

  • Add the amount you're behind to the end of the mortgage, which extends the term and cost of the loan

  • Renegotiate with the lender to reduce each monthly payment and then pay the difference, plus the amount you're behind, at the end of the mortgage

  • Temporarily reduce immediate payments and increase later ones, or make a balloon, or one-time, payment to catch up

  • Increase future payments slightly until you've paid up the amount you're behind

 
MORTGAGE PENALTIES
If you refinance, you'll come out better if your original mortgage doesn't impose a prepayment penalty. That's a charge the lender makes if you pay off your mortgage early for any reason. Some states forbid such charges, but the rest don't. And federal law allowing banks to impose prepayment charges may take precedence over state rules. Your attorney may advise you to avoid taking a loan that has a prepayment penalty if you have the choice. However, a loan with a prepayment clause may offer the advantages of a slightly lower interest rate or lower up-front costs that could make sense if you are certain you won't be moving.
 
 

 

 

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