As mortgage interest rates declined during the first half of 1998, the number of homeowners looking to refinance their existing mortgages went up. It's conceivable that some homeowners who have refinanced a mortgage within the last five years may decide to refinance again.
Caveat: Refinancing often makes good economic sense--but not always. Keep in mind that lower interest rates are only part of the entire equation. You must consider other factors--such as the fees you will spend in the refinancing process--to determine if refinancing is actually worthwhile for you.
For starters, refinancing often involves a lot of the same paperwork and closing costs you incurred the first time around. This may differ among lenders, but you may have to pay for title insurance, a survey, appraisals and other administrative fees. Next, there's the potential problem of "points." Each point represents one percent of the amount being borrowed. For instance, one point on a $100,000 mortgage equals $1,000; two points equal $2,000; and so on. You may find that a low-interest mortgage carries several points. On the other hand, you might have to pay only one point--or no points--on a slightly higher-interest loan.
Important: You cannot currently deduct the full amount of points when you refinance an existing mortgage. As a general rule, the points must be deducted over the course of the loan. (However, you may be able to fully deduct points in the year they are incurred to the extent the points are paid to acquire a home or make home improvements.) Does that mean you definitely should not refinance a mortgage when interest rates drop? Of course not. It just requires an in-depth analysis before you take any action. For instance, the length of time you expect to stay in the home may be a crucial factor.
Hypothetical facts: The Johnsons have an outstanding balance of $100,000 on their existing mortgage and 15 years left to pay. For simplicity, say that the monthly mortgage payment of principal and interest is $1,100. Assume that the couple is able to obtain a 15-year mortgage for $100,000 with an 8% rate compounded monthly. The monthly payment would be approximately $956--a savings of $1,728 a year.
Now let's say that the total cost of refinancing the mortgage is $5,000. If the Johnsons stay in the home for only two more years, they won t recoup all the money they spent on refinancing. In fact, they will be out $1,544--not to mention the time value of the money they paid up-front. However, if the couple keeps the home for ten years, they are ahead of the game by $12,280.
Be aware that there are other tax considerations. For instance, certain fees (e.g., attorney s fees) may be added to your basis in the home. This can reduce your taxable gain when you sell the home.
Bottom line: The following basic principle of refinancing is a rule of thumb only and should be considered in that context. In general, refinancing makes sense if both of the following conditions exist:
- The prevailing interest rate is at least two points below your existing rate.
- You expect to stay in the home for at least three years.
If you think you are in a position to refinance your mortgage, do some comparison shopping. It may be a good idea to check with your current lender.
Assuming that you have been a reliable payor in the past, the lender of your existing mortgage may waive some of the fees and paperwork that normally is required.
Final words: Talk things over with an experienced attorney who can guide you in the right direction.