Honey, I Shrunk the Mortgage - mortgage refinancing

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 9O/o.

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 dosing 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 to cut the amount of interest you shell out over the duration of the loan? Keep in mind that whatever the amount of your original mortgage, you'll likely pay two to three times that amount if you stay in the house for the entire life of a 30-year mortgage.

For example, for a $150,000 loan at 7.5%, you'll pay a whopping $377,561 over 30 years--$150,000, the principal amount, plus another $227,561 in interest. If you're worried primarily about interest charges, you might think about getting a shorter loan, say for 15 years, or doubling up on payments--instead of refinancing.

That's exactly what William and Cheryl Brown did when they refinanced their four-bedroom custom-built home in Douglasville, Georgia, a suburb of Atlanta. They bought the house in early 1996 and originally had an adjustable rate mortgage (ARM) that fluctuated when interest rates changed. With the ARM, their rate went from a low of 8.5% to a high of just over 12%. They refinanced, however, in 1998 and obtained a 15-year mortgage at a fixed rate of 9%.

The Browns, who adopted their nephew Eric but are expecting their first baby in February, plan to live in their home for many years to come. They calculated that refinancing will save them more than $100,000 over the life of the loan. Cheryl, 34, who works in the healthcare field, says refinancing has given the Browns more money to do other things--like save for their new addition to the family. "We've made a nursery for the baby," she says.

The couple's mortgage payment, excluding taxes and insurance, ranged at first from $1,500 a month to as high as $1,800 a month. Now they pay $1,300 a month. "Our refinancing worked out very well," says William, 38, a software engineer.

As the Browns' experience illustrates, refinancing can save you a good chunk of money. But if you're not careful, you can also wind up paying a hefty price--too hefty a price in some cases when you go to refinance your home. How can you lose out if you're getting a lower interest rate? By getting dinged with a ton of lesser-known fees.