Should I Refinance?

Maybe. Maybe not. It depends. The refinancing decision is not as simple as dividing your refinancing costs by your monthly saving, and then comparing this result to how long you likely will remain in your house. In other words, if it will cost you $3000 to refinance your new loan and you will save $100 per month, this decision is much more complex than to suggest it will take 30 months (i.e., $3,000 cost / $100 saving) to recoup your closing costs. One must consider the present value of the benefits of refinancing and compare to the present value of the costs of refinancing. Otherwise, many refinancing pitfalls may occur.

In particular, you should consider:

• Your anticipated holding period of the new mortgage loan
• When you plan to move
• When you plan to refinance again
• Your employment and credit history
• Prevailing interest rates today
• Anticipated closing costs to refinance, including discount points
• Your current interest rate
• The term of your current loan (e.g., 15 years, 30 years)
• The types of current and proposed loans (e.g., fixed-rate, ARM, balloon)
• The amount of equity you have built up
• Overhang (i.e., refinancing for longer than your current mortgage’s maturity)
• Retirement of debt before mortgage maturity
• Differential future unpaid mortgage balances of current and proposed loans
• Time value of money, given an appropriate discount rate

Generally, five reasons are offered for refinancing an existing mortgage. First and foremost, a borrower may wish to take advantage of lower prevailing interest rates, relative to the existing loan’s rate. All else held equal, this will afford a lower mortgage debt service payment. Second, a borrower may choose to change the type of financing. For example, one may refinance an ARM with a fixed-rate loan.

Third, one may wish to change the term of the current mortgage loan. Often, borrowers will refinance a 30-year loan with a 15-year loan. If this is done when rates are significantly lower than the contract rate on the existing mortgage, one may be able to keep the debt service payments about the same, although the term of the mortgage is reduced. Fourth, many borrowers refinance to draw some of their equity for the children’s education, retirement, health care, vacations, and so forth. Fifth, one may refinance to remove Private Mortgage Insurance (PMI), provided there is at least 20-25 percent equity in the home.

Of course, borrowers often refinance for several of these aforementioned reasons.