Does it make sense to refi?

Source:Bankrate.com Author:Holden Lewis Date:03/25/14 Click:

Refinancing a mortgage is currently the most pressing topic for many homeowners. With interest rates dropping, many want to know what to do. Senior reporter Holden Lewis, who covers mortgages and writes Bankrate's Mortgage Matters blog, answers the most common questions from readers. The broad question was developed from specific situations readers described to him. Over the next few weeks, he'll be answering questions on many aspects of the refinancing dilemma.

How do I decide whether it makes sense to refinance?
Q: Is it true that it is not really worth refinancing a 30-year mortgage unless it is to go down a full point of interest?
Q: At what point is it worth it to apply to refinance a mortgage? We have a 30-year fixed rate of 5.75 percent. We have good credit and would love to reduce our monthly payment. But will the fees and hassle outweigh the cost benefit?
Q: I am in the market looking to move into a larger house. I haven't seen anything I like at this point, but mortgage rates are low enough that I could refi and save some money. If I refinance now, and then want to purchase a home down the road, am I hurting my chances for getting that mortgage?

A: Give a manicure to those old rules of thumb that say you shouldn't refinance unless the rate has dropped by a certain percentage. To figure out whether it's in your best interest to refinance, you need to calculate your break-even point.

The break-even point is the time it takes to make up in monthly savings what you paid in fees. You calculate it by dividing the mortgage fees by the monthly savings. For example, let's say you would save $100 a month by refinancing, and the closing costs would be $3,000. Your break-even point is 30 months from now: the $3,000 in fees divided by the $100 a month in savings.

In this case, if you expect to continue living in the house for more than two-and-a-half years, you'll save money in the long run by refinancing. If you plan to sell the house before then, it's probably best to stick with the mortgage you have.

How do you figure your monthly savings? You'll have to get an estimate of the rate you'll qualify for. 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 would be with the new loan. Look at your payment coupon to find out what your current monthly principal and interest are. Now you can figure out how much you would save every month.

You don't have to start over with a 30-year payment plan, by the way. Let's say you got a 30-year fixed three years ago, and you want to refinance now, but still pay off the loan 27 years from now. That's known as amortizing the loan over 27 years. Bankrate's mortgage calculator, can help you figure out what your monthly payments would need to be.

The mortgage calculator's second item, "mortgage term," can be changed. The default is 30 years, but you can change it to another number of years. Press the "show/recalculate amortization table" button and there you go -- it recalculates your monthly principal and interest, and gives you a long amortization table, to boot.

If you refinance now, it probably won't hurt your chances of getting a mortgage a few months or years from now. Make sure your new loan doesn't have a prepayment penalty, and let the broker or loan officer know what your plans are.

Is it too soon to refinance?
Q: I bought a house last year and my interest rate is 6 percent. Is it worth refinancing now, after less than one year?
Q: I am in year one of a 30-year fixed mortgage of $400,000. My rate is 6 percent. I anticipate staying in this home for at least seven more years. When does it make sense to refinance?
Q: We've owned our home for six months with a fixed rate of 6.5 percent. When can we look to refinance? Is it too early to refinance within the first 12 months of owning a home?

A: No one's going to have a conniption fit if you refinance a brand-new mortgage. If you calculate your break-even point and decide that refinancing is right for you, go ahead and do it.

This applies even if the loan has a prepayment penalty. Just count the penalty as another mortgage fee. In many cases, you'll grudgingly conclude that it's better to wait until you're clear of the prepayment penalty period.

Do you have a question about refinancing? Ask us at editors@bankrate.com.

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