Honey, I Shrunk The Mortgage

Rates are low, and seldom has there been a better time to refinance your mortgage. Here's how, step by step.

Interest rates have fallen to some of the lowest levels in 30 years, and that has many homeowners wondering if they should refinance their mortgages. After all, who couldn’t use some extra money every month, since refinancing your mortgage can greatly improve your cash flow? By refinancing your home at a lower interest rate, you can reduce your monthly mortgage payment-freeing up funds that could be used for investments, retirement savings or some other purpose. Furthermore, refinancing can save you tens of thousands of dollars in interest over the life of a mortgage.

So how do you go about it? Before you call up your local banker, it’s important to do some numbers crunching to make sure refinancing makes sense for you.

Once upon a time, most experts agreed on this general advice: you should consider refinancing your mortgage when current mortgage rates are 2% less than your existing one. But that advice is far too simplistic. Homeowners have to be aware of the total cost of refinancing a mortgage. For some people, it may not be prudent to refinance, even if you can get a 7% rate and you’re now paying 9%.

How do you know whether refinancing is really worth it? You’ve got to do the math and take into account that you’ll be charged numerous fees-for title searches, appraisals, legal bills, etc. If these costs are excessive, or if you plan to move within a couple of years, you may be better off sticking with your present mortgage. These aspects of the complete refinancing picture have recently led some home financing experts to offer new guidelines.

James A. Lumley, author of How to Get a Mortgage in 24 Hours (John Wiley & Sons, $16.95) likes a variation on the old 2% rule, which he calls the 2-2-2 Solution. In this scenario, he says, refinancing may make sense for you “if the interest rate potentially available to you is 2% less than you are now paying, if you plan to stay in your home for more than two years, and if the refinancing charges don’t exceed $2,000.” Even using this criteria, Lumley cautions consumers to use the 2-2-2 Solution as a “thinking tool” rather than a hard-and-fast rule of thumb.

There’s another way, in five short steps, to calculate the wisdom of refinancing:

1. Figure out what you pay for principal and interest today. Simply put, what’s your current monthly payment (excluding taxes and insurance)?

2. Determine your future cost for principal and interest at a new and lower rate if all closing costs are paid up front.

3. Estimate how many months you plan to own the property.

4. Divide the monthly savings created by a new mortgage into the cost of refinancing.

5. If the number found in item four is larger than the number of months shown in item three, go ahead and refinance.

Whichever method you use, a key question to also consider is this: what is your overall goal? Is your aim simply to reduce your monthly mortgage payments? Or, are you trying

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