Refinancing Your Loan

Refinancing could be your next stop on the mortgage track if interest rates plunge and you plan to be in your house a while. As with any home loan, there are lots of options. Know what yours are before you get on board.

Refinancing your mortgage after you've just purchased a house may seem like a fruitless exercise but you could end up getting a whole new loan sooner than you think. Interest rates may drop below what you're paying for your current mortgage or you may suddenly come into extra funds to prepay enough equity to renegotiate your loan.

Homeowners tend to flock to lenders when interest rates dive; don't get caught up in the frenzy before you have the facts. If you change lenders, it may cost you a significant amount and you may not gain enough to make it worth the expense. You also may not recoup your costs if you plan to sell within three years or less.
But refinancing may be just the ticket to cutting your monthly payments and reducing the amount of total interest you'll pay on your loan.

Do the math

If you put less than 20 percent down to buy a house, you are probably paying a premium interest rate (the less you borrow, the less a lender will charge). Therefore you may benefit from refinancing if interest rates go down at least 1.5 percent lower than what you're paying on your loan now. The rule of thumb: For every quarter-point less in interest, you can expect to save about $20 a month. If rates go down 1.5 percent, that could mean as much as $120 a month less you have to pay your lender.

Longevity counts

Any savings you gain with a lower monthly payment, however, will be offset by what it costs to refinance, Loan origination fees, a new appraisal and new title insurance can cost as much as $3,000. But the longer you plan to live in the house, the more likely it is that you will recoup those costs. If you save $120 a month on your mortgage, and you pay $2,000 to refinance, you will recoup your refinancing costs in 16 months, a worthwhile investment if you're going to be in the house five years or more. On the other hand, if you plan to move soon and you will only save $50 a month by refinancing, it may not be worth it. Multiply the number of months you plan to be in the house by the savings per month. Compare this amount to what you would pay to refinance. If the fees are higher than the cost savings, it is not a good deal.

TIP: If you think you will be in your home for at least five years, consider leveraging your refinancing gain even more by paying a point or two (one point is 1 percent of the loan amount) on your new loan in exchange for an even lower interest rate. Points on a refinanced mortgage, however, are not deductible in the year you paid them as they are with a regular loan; they must be deducted incrementally over the life of the loan.

Other cost-saving strategies

Check with your current lender first: They may offer special refinancing packages to current customers, usually with at little or no cost to you. Competing lenders also may want to woo you with favorable rates or low costs. Call at least three for quotes.
Wrap refinancing costs into your new loan: If you have had your mortgage for several years, you may have built up enough equity to roll your refinancing costs into your new mortgage.
Switch from an adjustable-rate to a fixed-rate loan: If rates are low, this may be the time to switch to predictable monthly payment, especially if you don't plan to move soon.

Use your equity

Equity, or the actual financial stake you have in the house beyond what you owe on it, can be a useful tool when refinancing. If you have paid on your loan for a while, you may be able to refinance for more than your loan balance, essentially borrowing on your equity. The resulting extra cash can be used to pay off high-interest debt, such as credit cards, remodel the house, or use for something else. Also, you may want to refinance if you suddenly come into cash that allows you to increase your home equity, especially if you put down less than 20 percent. If you can boost your equity to 20 percent, you can drop private mortgage insurance and probably get an even lower interest rate in the bargain.

Call to ARMs

Adjustable-rate mortgages can suddenly look unattractive when rates dive and refinancing booms. Most adjustables have extremely low rates to start and gradually adjust upward, with increases as much as two points a year. But some adjustables start out fixed (typically at low teaser rates) for a specific time period, then convert to an adjustable. By refinancing before the loan converts, again and again, a borrower may hold on to the low teaser rate.

Bye-bye PMI

If you put down less than 20 percent to purchase your home, you must pay for private mortgage insurance, or PMI, on average $50 to $100 per month. But refinancing may offer you a way out of paying for PMI through a piggyback loan, a smaller second mortgage tacked on to your primary loan. With a piggyback, your new loan configuration may look like this, for example: 80% primary loan, 10% piggyback, 10% down payment. With an 80% primary loan, you don't have to pay PMI. Another savings: the tax-deductible interest on the second loan.