Current low interest rates are sending homeowners to the mortgage companies seeking to save money by refinancing. The question is: Is refinancing really worth the time, effort, and cost in the end? What most homeowners don’t realize, is that there is far more involved than just current interest rates when making the decision to refinance. What may look like a great deal can end up being just the opposite if you are not careful.

There are many things to consider when deciding if refinancing is right for you. When refinancing a mortgage, you typically pay off your original mortgage and take out an entirely new loan. This means that you will be paying many of the same costs that you paid to get the original mortgage. The cost of refinancing must be compared with the long-term savings to determine if refinancing is going to be to your advantage.

Costs that a new loan may incur include application fees, appraisal fees, credit reports, extra insurance, inspections, title insurance, underwriting, discount points, and perhaps even a penalty for paying off your initial loan early. Adding all these charges will determine the actual total cost. Also note that some of these fees may be hidden as they are just added to the balance of your new mortgage. By law, your lender must provide you with a Good Faith Estimate of closing costs, at the time of application. Ask for one earlier—the first time you discuss refinancing with your lender. While this is not an exact cost, a qualified lender should be able to give a fairly accurate idea of the end cost. A final total must be provided at the closing. Even after closing, you should have a few days to back out if need be. Make sure you are completely clear on all final costs.

It is also important to determine how much you will save from the refinancing. How much will your monthly payments be reduced? This can depend on the number of points you decide on when refinancing. Points are sums of money paid up front that reduce the interest rate. They are prepaid interest because they are paid at close instead of being paid over the course of the loan. A point is generally one percent of the amount financed. For example, one point for a $80,000 loan will equal $800 that will need to be paid up front. The more points you pay initially, the lower your interest rate will be and the fewer points, the more interest you will pay. However, paying points may not be to your advantage if you sell your home within a couple of years. Also check with your tax preparer to determine if the prepaid interest is deductible from your income taxes.

Once you have figured the total cost to refinance and the total amount you will save each month with the new loan, compare the two so you can figure the pay-back period. Take your total costs and divide them by the amount you will save per month. This will tell you how many months it will take you to break even on your refinancing. For example, if your refinanced mortgage cost you a total of $3,000 and will save you $150 per month, it will take you 20 months to see the benefits of refinancing. In this case, after 20 months, the new payment will start to save you money.

You must also consider how long you will be staying in your current home. If you were to move before you broke even from your refinance, you would lose out on a lot of time and money. Make sure that you plan to stay in your home before you decide to refinance.

How long you have been paying off your current mortgage can also be a deciding factor when refinancing. For example, if you have already been making payments on your mortgage for 10 years and then you refinance, the new mortgage is going to push the date you would be retiring your mortgage back and you may pay a significant difference in the end. This problem can be solved, however, if you are able to refinance for a shorter-term loan, perhaps a 15-year instead of a 30-year term.

If refinancing looks like a good deal to you after weighing the pros and cons, your current mortgage lender is a good place to contact first. It is possible that they will have special deals to retain current customers. Use the deal your lender offers you as a guide as you shop around (lenders list follows). Make sure to talk to people you know and trust to see what their experiences with refinancing have been.

 

Refinancing May Be a Good Idea If…

• The interest rates of your new loan are significantly lower than your current loan
• You want to shorten your mortgage payment period
• You do not plan to move before you would start seeing the benefits of refinancing
• You want to use equity that has built up in your home since you purchased it
• You want to switch from a adjustable mortgage rate to a fixed-rate, or vice versa
• You have not been paying off your current loan for a long time
• Your current loan does not charge a penalty for paying your loan off early

 

Refinancing May Be a Bad Idea If…

• You are unsure of how long you plan to stay in your current home
• Interest rates are only a little lower
• You have paid off a large amount of your current mortgage
• You will have to pay a fine for paying your loan off early

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