My husband and I are going through the rigmarole of refinancing this week, gathering proof of income and tax returns and calling settlement attorneys. We finally decided it was time for us to take the plunge because interest rates for our type of loan have dropped enough to make it worthwhile. But, in this crazy economy, who knows if our timing is right.
Refinancing can be a gold mine where you find money -- or a mineshaft where you pour your money. It all depends on three factors on a sliding scale -- how much you can reduce your interest rate, how much you'll pay in closing costs and how long you plan to live in the home.
The old rule of thumb was that you should refinance if you could get a rate two points lower than your current rate. That seems almost quaint now because rates are so low across the board.
Now mortgage experts say to investigate refinancing if you can lower your rate by even half a point. My husband and I finally went for it when we could reduce our interest rate by one full point. The longer you plan to keep the house, the smaller the reduction that will benefit you because you'll have time to recoup your closing costs.
The real key is the break-even point. That's the number of months you should plan to keep the home after refinancing in order to recover your closing costs.
For example, if you pay $3,000 in closing costs and you manage to lower your mortgage payments by $150 a month, you would reach the break-even point in 20 months. As long as you plan to live in the home longer than that, refinancing could be worthwhile. It's a sliding scale. The smaller your savings, the longer you need to stay put.
There are a couple strategies to tweak the sliding scale by minimizing the price of closing costs when you refinance.
One is to ask your current lender to refinance you. In order to keep your business, your lender may be willing to waive certain closing costs.
Ask for the "reissue rate" on your title insurance, a savings of 40 to 50 percent.
Ask for an automated or drive-by appraisal, which is cheaper than a full-fledged one.
And get your lender to skip the credit check. After all, the company is intimately familiar with your payment record.
When to Wait
Your other choice is to shop for "zero-cost" refinancing. That's an obnoxious name for it, because it's not actually free, but you do avoid upfront costs. Simply ask the broker or lender to absorb your closing costs by raising your interest rate by an eighth or a quarter of a percent.
True, you don't get the lowest possible interest rate, but if you only plan to keep the home for a few years, maybe that doesn't matter. The benefit is that you immediately cut your interest rate and monthly payment with no out-of-pocket costs.
There are other factors that complicate refinancing decisions.
For example, did you ever consider that by reducing your interest rate, you reduce the amount you can write off on your taxes? In close cases, this could tilt the teeter-totter in favor of sticking with your old loan.
The length of the loan is another variable. For example, if you're approaching retirement and your old loan is almost paid off, refinancing could extend the length of your loan and cost you more. If you're several years into a 30-year mortgage, don't refinance into another one. Instead, try for a 15- or 20-year mortgage.
That will lessen the number of years you pay interest and save you big money long term.
Here's a calculator to get you started analyzing whether it's time for you to join me and refinance your home. Now, I have to go print off my pay stub.