Is a Refinance the Right Decision?

Housing finance options and information

Once at rock bottom, interest rates have ticked up slightly. But the prospect of refinancing a mortgage is still attractive. Find out if it's a smart move for you.

Months ago, according to Freddie Mac statistics, interest rates fell to record lows. If you didn't refinance your mortgage at that time, a refinance still could be a good financial move now. Do your homework to see if a refinance makes good financial sense — but make a decision soon.

An August 2013 Freddie Mac study reports that interest rates are projected to rise to 5% or above by August 2014.

"The window hasn't closed, but homeowners should analyze their mortgage situation to see if a refinance can improve their overall financial picture," says John Young, director of real estate product management at USAA.

Mike Fratantoni, vice president of research and economics at the Mortgage Bankers Association, agrees. "When market rates were at 3.5%, 90% to 95% of outstanding loans would have benefited from a refi," he says. Now, with mortgage rates at about 4.4%, he says that just 25% to 30% of homeowners with outstanding loans would come out ahead.

Here's a guide to the current refinancing marketplace and the factors to consider when making your decision.

Why refinance?

Homeowners consider a refinance to:

Pay off your mortgage early. Moving from a 30-year term to a 15-year term without a big jump in monthly payments could save you thousands in interest and help you build equity in your home faster.

Create more cash flow. Lower interest rates can create lower monthly mortgage payments, freeing up money to pay down debt or just to provide more wiggle room in the budget for other things.

Access home equity. On a cash-out refinance, you borrow more money than you owe on your current loan, and use the funds for purposes such as reducing other debt, remodeling your home or just recovering from a financial setback. "As home values start to rise, there is some pent-up demand for a cash-out refinance to access the equity in the home for other purposes," says Diane Brooks, real estate product management director at USAA.

Would refinancing benefit you?

Fratantoni puts today's mortgage holders into three categories:

  • Already refinanced: Those with strong credit, job security and plenty of home equity. These homeowners have refinanced in the past few years and secured a rate in the low- to mid-3.0% range.
  • Already refinanced through federal programs: Those with good credit and employment but not enough equity to qualify for traditional refinancing. These borrowers only qualify to refinance through federal programs such as the Home Affordable Refinance Program, known as HARP, or the Federal Housing Administration's streamline refinance — both advantageous to a homeowner who owes more on his mortgage than his home is worth. (Consumers must work directly with their loan servicer for the HARP; USAA works with the FHA through our Military Home Loans Joint Venture). Fratantoni notes that many homeowners who qualify for those programs have refinanced.
  • Current candidates for traditional refinancing: Those who have regained their financial footing after a job loss or credit trouble, or who are no longer underwater as home values rise. Those from Category 1 who never refinanced also fall into this group.

USAA's Brooks would add a fourth category for recent purchasers who secured a low-interest-rate mortgage. A refinance for these mortgage holders, she explains, does not make sense.

If you're in the market to refinance, consider these factors:

The numbers. Do your financial homework, says Brooks. "It's not just about payment savings. That's not the whole story," she says. How quickly will you recoup closing costs — typically between 2% and 5% of your loan? How long do you plan to stay in the home? How long are you extending the term?

Your emotions. Doing the numbers may not reflect how badly you want more cash flow in your budget or how passionate you are about that kitchen remodel. So even if the numbers aren't optimal, there still could be enough of a financial and emotional boost to justify a mortgage refinance. Just remember, you are leveraging your home, Brooks says.

Need for flexibility. A 30-year loan, while having a slightly higher interest rate, can provide a lower monthly payment that's more manageable in lean financial times. Young explains, "On a 30-year loan, you can make a larger monthly payment to pay the loan off in 15 years. If you run into cash flow problems, you can always make the minimum payment. Refinancing for a 15-year loan, while getting you a better interest rate, will also get you a higher minimum payment that must be paid on time."

Financial readiness. Ask yourself these questions:

How's my credit score? A stellar credit score can help you get a good interest rate.

  • How will I pay closing costs? Plenty of people roll them into the refinanced loan amount. But, Young asks, "Do you want to pay interest on the closing costs?" Saving enough to pay for the closing in cash can make the refi an even better deal.
  • Where does my mortgage fit into my family's financial picture? Consider your overall budget, investments, college savings plan and other financial goals.

Discipline with savings. If your refinance lowers your monthly payment, what will you do with the extra cash? Many people don't have a good strategy for this additional monthly savings. Ideally, the payment savings should be applied to other debt or to boost your savings account, Brooks says.

When Refinancing Doesn't Make Sense

  • If you're closer to the end than the beginning of your term, don't start over. If you're 18 years into a 30-year term, you're paying more toward principal than someone just three years into a 30-year loan.
  • If your rate is not much lower. The rule of thumb says the mortgage interest rate on a refi should be about a point or more lower than your current rate before you even consider a refinance.
  • If you don't know how long you'll be in the home. Are you planning to move soon? Could you be relocated for a job? You may not recoup closing costs if you have to have to sell your home sooner rather than later.
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