Refinancing your loan

An old rule of thumb teaches that if rates drop by two percentage points, then it's time to refinance your mortgage. However, in today's market, if you're planning to stay in your home for a while, and you find a good deal on refinancing costs, it may be worthwhile to refinance with only a 1 percent lower rate.

Refinancing involves many of the same steps and the same types of closing costs you encountered when obtaining a mortgage the first time around.

Tip

When refinancing a loan, the lender is not required to give you a "good faith estimate" of closing costs. So be sure to request one before deciding whether it pays to refinance.

Besides a lower interest rate, other reasons for refinancing include converting from an adjustable to a fixed-rate mortgage, or wanting to build equity sooner by converting to a shorter-term mortgage. Some homeowners may want to draw on the equity they have already built to get cash for a major expense, such as their children's education.

Some lenders offer "no-cost" refinancing, but this usually involves a higher interest rate.

In order to refinance, your home must have enough value to justify a new loan. Many people who bought homes at peak prices in the late '80s were disappointed to learn that they could not refinance their homes when mortgage rates dropped in the early '90s, because the value of their homes fell and they had little or no equity in their property. To qualify for a lower-rate mortgage, they would have to make a new down payment on the home in which they're already living.

Does it Really Pay?

To figure out whether it pays to refinance, answer a few questions and do some arithmetic:

• Figure monthly savings: How much would you have to pay monthly under a new lower-rate mortgage? Subtract the new payment from your old payment to find out the monthly savings.

• Figure total cost: What is the total cost to refinance? Add up the costs of any points and other fees on the loan, title search, and new appraisal.

• How many months will it take to break even? Divide your total cost by your monthly savings.

Example: Let's say the total cost of refinancing is $3,000, and your monthly payments on the new loan are $150 lower. It will take you 20 months to break even. If you don't plan on staying in the house that long, it won't pay to refinance.