Should You Refinance?

With mortgage rates near their historic lows, it is tempting to want to refinance your mortgage. You may be able to lock in a lower rate, or lower payments. Or refinance a long loan into a short loan, and kill your mortgage debt early. You may even be able to take money out of your home and pay off other high-interest-rate debts (though that is neither as easy nor as risk-free as it once was, given the sharp drop in home values).

You may be a good candidate for a refi loan if:

• You have a good credit score.
• You have secure income and can afford the payments.
• You have equity in your home; that is, it is worth more than you owe on it.
• You still have many years to pay on your loan.
• Your loan is now at an above-market interest rate.

Of course, even if you don't fit those criteria, you might still want to refinance, and new government rules may allow you to (I'll get to them in a minute). But for now, traditional refinancers should reconsider this.

Sometimes a refinance can be a bad move. Say, for example, that you owe only 10 more years on a 6 percent loan. You could refinance for 30 years at 4 percent, but then you'd have to pay for 20 additional years--the refi would end up costing you a lot in interest, not to mention closing costs.

The rule of thumb used to be that it was worth refinancing only if you could cut your interest rate by two percentage points, but that no longer is valid. Now, some people find it worthwhile to refinance for only 0.5 percentage points.

There's no shortcut to answering this question; you have to do the math. Get some solid refinancing quotes, including closing costs, and ask yourself these questions:

• How will it affect my monthly payment?
• How will it affect my total payments over time?
• How will a new mortgage fit with my other financial goals? (For example, if a refinance would get your mortgage paid off before your kids go to college, that's a good thing. If it would spread your payments well into retirement, that might be a reason not to refinance.)
• What is the break-even point? (That is the year when you actually begin to save money by refinancing. Typically, the addition of closing costs means that you actually spend money to refinance for the first few years. The bigger the rate differential between the new loan and the old loan, the quicker you'll break even.)

If your break-even point is much closer than the end of the time you expect to be in the house paying off the loan, then the refi is probably a good idea.

Excerpt from Master Your Debt by Jordan E. Goodman with Bill Westrom.

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