We are witnessing the lowest mortgage rates in two generations. According to Freddie Mac’s June 7, 2012 survey, the average rate on a 30-year fixed-rate mortgage fell to a record 3.67 percent while that for a 15-year mortgage fell to 2.98 percent (Refer note 1 below). Further many economists predict that mortgage rates would rise later this year. Should these provide compelling need for you to refinance your home loan?
The following would provide sufficient points on when you shouldn’t opt for refinancing.
One of the primary assumptions to go for refinancing is that you expect the property prices would go up and there would be equity appreciation down the road. If recent history is any indication, such an assumption may not be true. According to Federal Reserve, the median family’s networth declined about 40 percent between 2007 and 2010, primarily due to home-equity depreciation.
Hence you shouldn’t go for refinance by betting on property price movement.
Next keep in mind the number of months of savings it would take to equal the upfront cost of obtaining the refinance. Even if the lender provides ‘no cost’ refinancing, the lender would somehow roll these costs into your new loan. You can have a look at the refinance cost at page 2 of the Good Faith Estimate.
If you divide the refinance cost by the monthly savings due to lower payments, you will get the number of months it will take to break even. If you sell the property before such computed break even period, it would be a bad idea to refinance.
One would generally need to have at least 20 percent equity in order to refinance without need to pay Property Mortgage Insurance (PMI). With the continuous fall in property prices during the past few years, you might not have sufficient equity and hence you have to shell out the additional PMI charges.
Sometimes refinance would help you with a ‘cash-out’ refinance wherein the mortgage bank would actually write a lump sum check in your favor.
However you should judiciously use such extra refinance amount. For instance, if you use the amount to pay-off your lower-interest loans or obligations, it might not be beneficial in your case. Similarly if you invest such extra amount in investment products, you would be exposed to ‘double whammy’ of losing on the investment front and paying mortgages for longer term.
Refinance can facilitate lower monthly payments either due to lower interest rate or extending the loan term.
However a smart borrower would evaluate various factors to ensure that refinance would actually be beneficial in his case before opting for refinance. Else he might end up spending more by refinancing than if he had stuck with his current mortgage.
Over the last 4 years, Allan has contributed numerous posts on home loan refinance and debt consolidation options. When he is not blogging, Allan is a committed member of several personal finance forums and a regular reviewers on prominent personal finance sites.
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