I Should Refinance When…
by Marc Hopkins

Whether the market is going up or down, I am constantly asked if it is the right time to refinance. It is a very individual decision, but there are some key indicators to help you decide. All loans and personal circumstances are different, so, while these are good guidelines, you should talk to a loan officer you can trust to see what is right for you.
Prepayment penalties: If you do not have a prepayment penalty or if your time has passed, then you can skip forward. If you do have one then it is important to know how much you will have to pay. If your prepayment penalty is less than a year away it is often better to wait. If it is more than a year away then the new loan should help you recover the prepayment fees quickly, usually two years or less, for it to make sense.
Interest rate: Usually a refinance should either fix or lower your rate for a refinance to make sense. If you are in an adjustable loan your new rate could be potentially higher than your existing rate, but if it stops the rate from going much higher when it adjusts then it makes sense. Otherwise the rate should go down at least 1% for the savings to justify the refinance, although in some circumstances a homeowner could benefit from a drop of less than 1%. If there are multiple loans on the property, such as a second mortgage or equity line, there is a good chance by consolidating the loans into one the interest rate on the first might increase slightly, but when offset by the savings on the second loan overall the rate is lower. For a refinance to make sense the interest rate should be lower or there is a solid justification, such as preventing the rate from going higher, if it will be equal or slightly higher.
Fees: From title insurance to appraisals there will be fees incurred in the refinance. Most often these fees are paid by the homeowner, usually wrapped into the new loan so there is no out of pocket expense. Even though there may not be a check written by the borrower if the fees are excessive, it does not make sense to refinance, even with a lower monthly payment. If there are $10,000 in fees even with a savings of $200/month it will take over 4 years to even break even on the loan. The only true “No Cost” loan is one in which no fees are paid, the principle remains the same, and the interest rate is lowered, any other loan will cost one way or another.
Payment: Unless the term of the loan is shorter or it made sense to refinance at a higher rate as discussed above, the monthly payment on a loan should decrease for a refinance to make sense. This is also important in calculating recovery of a prepayment penalty or closing costs. For example if there is $3,600 in fees with a savings of $150/month on the monthly payment it will take 2 years before “breaking even” on a loan. Another important way to lower payments is by removing PMI or mortgage insurance from the existing loan, but be cautious if this is the only motive as often this can be removed with a simple call to your existing lender and does not need a refinance. The idea of refinancing most the time is to lower payments and free up monthly cash flow, but it must make financial sense with costs recovered in a reasonable amount of time.
Time: All of the above share one factor, and that is time. How long will it take until the costs of the refinance are recovered? As a general rule it should take no more than 3 years to recover all costs, although there are of course exceptions. If the plan is to refinance again or move in less than the time it takes to recover the costs then it does not make financial sense to refinance the home. Any monies not recovered are lost so make sure the plans are to remain in the home long enough to at least break even.
Although those are the primary questions to ask, there are other factors to consider. For example, how will it affect taxes? If the interest is lower there could be less to deduct at the end of the year. How will it affect the equity in the home? Even if the principle remains the same, since the loan has been reset the first few years of payments will be primarily interest and thus the home will build equity more slowly. When will the home be paid off? Unless the term is lowered, refinancing resets the pay off date out for another 30 years.
If there is a need to pull cash or equity out of the home or to get out of a bad loan then it could make sense to refinance even though the above criteria is not met. Even if all the mentioned criteria are met it still might not be the right thing to do. Before rushing into a new loan to save a few dollars a month or to lower the interest rate, talk to a trust worthy mortgage broker or loan officer or go online to review the individual circumstances and make an informed decision.

~ Marc Hopkins is a licensed Mortgage Consultant and Notary Public at Brentwood Pacific Financial. He can be reached at 408-307-8242 or e-mail him at mhoppi@msn.com