Sunday, September 16, 2007

When to Refinance

Refinancing your 1-year ARM maybe a no-brainer given today's volatile credit markets but what about the rest of us. Recently I evaluated the merits and disadvantages of refinancing my 30-year fixed mortgage. Before you get entangled into the details of points, lenders, rates and APR - consider the following points...

Closing costs - Any refinancing will entail closing costs which are the transactional expense and cannot be avoided. These costs are usually out of pocket (meaning need to be paid by you at closing) but sometimes can be rolled into the overall mortgage. Then you are financing this expense also for 30 years. If you are refinancing to lock in a lower rate - remember this closing cost will be added expense. If the difference between the old loan and new loan is $100/month and your closing cost was $2000 - it will be 20 months before you will start to realize the benefit of this refinance. Bottom line - closing cost have a significant impact on your refinancing transaction.

Loan term - If you have paid off 5 years of your 30 year loan and refinance for another 30 years - you have effectively taken a loan for 35 years. The more the loan duration - the more interest you pay. Also - interest accounts for a substantially large part of the payment in the early years - principle applied towards equity is minimal. So if you refinance with the same terms not only you extend the duration of your loan - you end up paying more in interest. Consider reducing your loan term when refinancing.

Do your homework - Refinancing is a tedious process. Do your research to confirm that there is merit in refinancing. Are you planning to stay in the house for sufficient time to derive the benefits of refinancing? Are interest rates lower to provide you with a significant reduction in monthly and eventually overall interest payments? Do you clearly understand the cost associated with the refinance - closing costs, loan terms, restrictions, other fees, rates/points etc.? Invest the time now to make a prudent refinancing decision and save money in the long term.

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