Is It Time to Refinance? Three Questions to Consider

Is It Time to Refinance?
Three Questions to Consider
Leonard Baron, MBA, CPA, and author of Real Estate Ownership, Investment and Due Diligence 101

So you've read that interest rates are near historic lows and you want to figure out if you can refinance. Financing has become significantly harder to do and more expensive in the past few years, thanks to the financial crisis. But refinancing is still possible and may make financial sense.

In this article, we will run through some of the basic issues you should contemplate to help give you a framework for deciding whether to refinance. The best person to help you sort through this framework and help you reach a final decision about when to refinance is your mortgage lending professional. But doing a little homework beforehand will help you ask your mortgage professional the right questions.

Here are three questions to consider when you are thinking about refinancing:

Planning on moving? The first item to consider is whether you're going to own the house in question for at least two to four more years–the longer the better. If you're not planning on owning for at least a couple years, refinancing may not be a net benefit to you. HOWEVER: The bigger the mortgage, and the bigger the differential between your current mortgage interest rate and the rate you might get by refinancing, the more refinancing might make sense even on a shorter term basis like two years. So rather than dismiss the idea, this is a good topic to discuss with your mortgage professional in terms of your unique situation.

Can you even qualify for a refinance? It can be tough to refinance these days. If your loan-to-home-value ratio is too high–meaning that your property doesn't appraise at a high enough value in comparison to the amount that is still outstanding on your loan–it may be harder to refinance. The bank may also consider you to be a higher risk if you're self-employed, have a high debt-to-income ratio, or if you have credit issues. But the only way to know for sure is to check with your mortgage lender to examine your options.

What are the costs versus the reduction in interest rate? If you are qualified for financing, your lender will also let you know what interest rate you can secure and how much it will cost you to refinance. You can then do a rate versus loan fee comparison to see if refinancing makes sense. For example, if you refinance a $300,000 loan it might cost $6,500 once you add up points, escrow, title, appraisal, etc. If your loan is dropping by one-half of a percentage point you will save $1,500 per year, which is about $1,000 after taxes. So if you are paying $6,500 to save $1,000 per year, it will take you 6.5 years to earn your money back. That may or may not be a good deal for you, depending on how long you are planning to stay in your home. The bottom line is add up all the costs you will incur by refinancing (remember to exclude items like prepaid interest, taxes and HOA fees that you pay whether you refinance or not) and compare these to your cost savings. This will help you determine whether now is the time to refinance.

Generally speaking, it can be time consuming and challenging to properly dissect the costs versus benefits of refinancing a property. That's why it's a good idea to talk to your trusted lending professional, who understands the right questions to ask and can help you work through the details to make an informed decision.

If you have any questions about your personal situation, contact the professional who supplied you with this month's issue of YOU Magazine. Take action now, so you are protected when you need it most.

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Is It Time to Refinance? Three Questions to Consider