To Refinance or Not - That is the Question

April, 2009

When deciding whether to refinance your home mortgage there are several general rules to follow:

1) Will your interest rate go down by more than 1 per cent and will you be able to recoup the refinance fees (approximately $1200) over a 12 - 18 month period while saving at least $100 per month in your mortgage payment; or

2) Is this the lowest interest rate you believe you will ever be able to take advantage of even though it takes you 2 - 2.5 years to pay off the refinance fees?

Added to these rules is the over-arching question of how long you intend to own your present home. In other words, if you plan to sell your house within a year then in neither scenario would it make sense for you to refinance since you won't be able to realize the benefit of a refinance within that one-year period. The second situation described above usually only makes sense financially when you plan to own your home for an extended period of time.

Other general rules include:

1) If you can afford a 10 or 15 year mortgage, it makes sense to shorten the term of your loan;

2) If there is only a ¼ to 3/8 difference in the interest rate between a 15 and a 30 year mortgage, then keep the 30 year mortgage. You can always make extra payments to reduce the life of your loan if you wish;

3) During tough economic times, it may make sense to keep a 30 year mortgage with lower monthly payments in the event of a job loss or cutback in hours;

4) An extra payment per year shaves off approximately 7 years on a 30 year mortgage; and

5) If you plan to move in the next 3-5 years, you will probably not be able to recoup points paid to buy down your interest rate.

Another option to discuss with your lender is to combine a first mortgage and a second home equity loan/line of credit. The general rule governing this situation is to add the principal balance of your first and second loans together. If they total less than 80% of the value of your home, then it makes sense to apply the refinance rules listed above to decide if you should refinance into one mortgage.

One caveat: if you think you have a deal that's just too good to be true - it probably is. Ask for the Good Faith Estimate from each of your lenders and compare them with one another. The Good Faith Estimate should include all of the fees associated with the refinance and you will be able to see a breakdown of the costs between loan offers.

Note of thanks to Scott Zimmer from Goodfield State Bank who supplied much of this information.