Refinancing Motives

Refinance to Lower Payments --
or Avoid Higher Ones

With long-term mortgage rates flirting with 5% again, many homeowners should revisit whether it makes sense to refinance.

Refinancing (assuming you can) is appropriate in two situations: 1) you're able to substantially lower your monthly payments; or 2) if you don't refinance, you face the prospect of substantially higher monthly payments. It's also relevant whether you're planning on staying put or not: there's no point in paying to upgrade a mortgage that you're not going to keep.

Ultimately, the decision to refinance is just a cost-benefit analysis.

The cost is the 2.5%-3% or so you can expect to pay for the new loan (unfortunately, about the same cost as the original, purchase money mortgage).

The benefit is the reduced monthly payment.

To use concrete numbers, if you currently owe $250k on a 30 year, 6.25% mortgage, you could reduce your monthly payments about $200 by refinancing at 5%. If the cost to refinance was $6,500, you'd recoup the fees in a little less than 3 years. Over the life of the loan, your savings would total an impressive $72k! (You'd have to partially offset that by what you'd have if you'd instead invested $6,500 for 30 years).

My mastery of hurdle rates, internal rates of return, etc. was never that good -- and is nonexistent now -- but intuitively that seems like an attractive proposition.

Even if you can't improve your situation, you may want to refinance to prevent it from getting worse. That's the case if your current mortgage is set to adjust to a substantially higher rate soon, is non-amortizing (interest only), or negatively amortizing (the amount you owe actually increases).

In any case, to qualify for refinancing at all, your credit scores must be decent (mid-600's or better), and you must have sufficient equity to serve as collateral. Unfortunately, that disqualifies many homeowners who bought in the last couple years with little or nothing down, and have seen their homes drop in value.

If you're a bona fide refinancing candidate, here are three tips: 1) be sure to ask for the federally-mandated disclosures (the Truth-in-Lending, or "TIL," and the Good Faith Estimate; 2) inquire about a re-lock option, which lets you capture a lower rate if they drop while your application is pending; and 3) shop around.

Money is fungible, and quoted fees vary. Think of it this way: before you spent $6,500 on a used car, new roof, etc., you'd expect to do some due diligence, wouldn't you?