There are a variety of good reasons for refinancing your mortgage. Many homeowners refinance because they want a better mortgage rate, a lower payment, they’re unhappy with the lender, or need to borrow cash from their home equity. These are all valid reasons for refinancing your mortgage, despite the so called “two percent rule.”
The “two percent rule” states that you should never refinance your home mortgage unless the new mortgage rate is two percent lower than your existing rate. The two percent rule oversimplifies the possible benefits of refinancing and is simply bad advice. Many homeowners elect to refinance their Adjustable Rate Mortgages with a fixed rate loan because of the financial risk associated with variable rate loans. Fixed rate mortgages typically come with higher interest rates than their Adjustable Rate Mortgage counterparts so it may not be possible to refinance two percent lower.
Instead of basing your decision to refinance on whether or not you can qualify for a mortgage rate that is two percent lower, you should make your decision based on your needs for the new loan. Refinancing your mortgage will cost you money; if your goal for the new loan is to save money you should consider how long it will take you to recoup your expenses before you realize a savings.
For homeowners looking to cash out equity in their homes a lower interest rate may not be possible; similarly, homeowners refinancing with a shorter term length may not be able to lower their monthly payment. If your goal is to lower your mortgage payment by qualifying for a lower mortgage rate you can calculate how long it will take you to recoup your expenses based on your lower mortgage payment.
To calculate the break even point divide how much it will cost you to refinance including points and settlement fees by the amount you are saving each month. Suppose it will cost you $4,000 to refinance and your new mortgage payment will be $200 lower. With this lower payment it will take you 20 months ($4,000/$200) to recoup the expense of refinancing. If waiting almost two years before realizing a savings from your new mortgage is acceptable to you, then refinancing makes sense in your situation.
Remember there are no hard-set rules when determining if mortgage refinancing makes sense in your situation. Evaluating the cost of obtaining the new mortgage will help you make your decision; however, you should weigh the benefits against the disadvantages of refinancing.
What are the Disadvantages of Mortgage Refinancing?
The main disadvantage of refinancing your mortgage aside from the cost of taking out a new loan is the fact that the clock is rewound to the beginning when it comes to repayment. Mortgage loans are front-loaded with interest and when you refinance you start the amortization schedule from beginning. Amortization describes the process of repaying your loan principle and interest over time. This means at the beginning of your loan the majority of your payment is applied to interest and very little goes to paying down the principle balance. Your tax deduction for mortgage interest will go up because of the higher interest payment; however, you will build equity at the slowest possible rate for you loan.
Mortgage Refinancing Has Tax Benefits
If you are considering refinancing your mortgage to payoff high interest debt like credit cards you will gain a tax-deduction for the interest paid on this debt after refinancing. Not only will you significantly less in finance charges for this debt but the interest paid is fully deductible every year on your Federal Income tax. Remember that while debt consolidation has many advantages it does not eliminate your debts but simply rearranges them making it easier to pay off.
A Lower Monthly Payment Can Free Up Cash For Other Things
Refinancing your mortgage with a lower monthly payment can free up cash in your budget for other things. If you’re a homeowner struggling to make ends meet a new mortgage could give your budget some much needed relief. There are risks associated with certain types of Adjustable Rate Mortgages and many homeowners are tempted with lower payment interest only and option loans. While it’s true that an option loan could get you a lower monthly payment, homeowners who abuse the “minimum payment” that comes with these loans could find themselves underwater when the lender recasts their loan.
Never take shortcuts when it comes to mortgage, foreclosures rates in the United States are rising significantly because homeowners are abusing these risky Adjustable Rate Mortgages. The decision to refinance your mortgage should not be taken lightly; your goal should be to approach lenders as a educated homeowner when refinancing. This will enable you to make a rational and informed decision whether or not a new mortgage makes sense in your individual situation. Doing your homework along with researching lenders and their mortgage products is free; however, neglecting this step when refinancing could cost you a bundle.
You can learn more about your mortgage refinancing options, including expensive pitfalls you need to avoid with my free mortgage video tutorial. For immediate free access to the tutorial and all videos click on the DVD image at the top of this page. The tutorial is completely free with no obligation to you now or in the future.
My name is Rob Regehr and I’m a personal finance writer with a chip on my shoulder for banks and brokers that take advantage of my friends and neighbors.
