Refinance Information

Should you refinance your home mortgage? That's a question many homeowners ask when lower mortgage rates become available.

But, how do you decide if refinancing makes sense in your particular case? The answer depends on many factors, including your tax bracket, the length of time you plan to stay in your home, and the additional costs and charges you must pay for the refinancing.

Refinance Costs

Refinancing your home costs money. There are just as many costs as when you purchased, zero cost mortgages involve a higher than market rate that will cost you in the long run.

When you refinance your mortgage, you usually pay off your original mortgage and sign a new loan. With a new loan, you again pay most of the same costs you paid to get your original mortgage. These can include settlement costs, discount points, and other fees. You also may be charged a penalty for paying off your original loan early, although some states prohibit this. The total expense for refinancing a mortgage depends on the interest rate, number of points, and other costs required to obtain a loan. To obtain the lowest rate offered by the lender, most lenders will charge several points, and the total cost can run between three and six percent of the total amount you borrow. So, for example, on a $100,000 mortgage, the lender might charge you between $3,000 and $6,000. However, some lenders may offer zero points at a higher interest rate, which may significantly reduce your initial costs, although your payments may be somewhat higher.

Interest Rate Savings

The most common reason to 'refi' is to lower your interest rate. Conventional wisdom is to lower two points, but even one point can make it worthwhile.

Talk to some lenders to determine the available rates and the costs associated with refinancing. These costs include appraisals, attorney's fees, and points. Then determine what your new payment would be if you refinanced. You can estimate how long it will take to recover the costs of refinancing by dividing your closing costs by the difference between your new and old payments (your monthly savings). However, the ultimate amount you may save depends on many factors, including your total refinancing costs, whether you sell your home in the near future, and the effects of refinancing on your taxes. The old rule of thumb used to be that you shouldn't refinance unless the new interest rate is at least two percentage points lower. However, many lenders are now offering zero point loans and low-cost refinancing. Therefore, even if your rate change is less than one percentage point, you may be able to save some money by refinancing.

Refinance Points

This can vary depending on what interest rate you want to refinance at. If it is lower than market rate, you may have to pay discount points.

In refinancing, lenders usually offer a range of interest rates at different amounts of points. A point equals one percent of the loan amount. For example, three points on a $100,000 mortgage loan would add $3,000 to the refinancing charges.

Shopping for points as well as interest rates may save you money. As a rule of thumb, each point adds about one-eighth to one-quarter of one percent to the interest rate the lender is offering.

Generally, the lower the interest rate on the loan, the more points the lending institution will charge. Some lenders offer refinancing with no points, but generally charge higher interest rates.

To decide what combination of rate and points is best for you, balance the amount you can pay up front with the amount you can pay monthly. The less time that you keep the loan, the more expensive points become. If you plan to stay in your house for a long time, then it may be worthwhile to pay additional points to obtain a lower interest rate.

Some lenders may offer to finance the points so that you do not have to pay them up front. This means that the points will be added to your loan balance, and you will pay a finance charge on them. Although this may enable you to get the financing, it also will increase the amount of your monthly payments.

 Income Taxes

Escrow, or Impounds, can be tricky business when you refinance. You will need to reestablish your account with the new company and your existing company will refund your current balance within 30 days.

With a lower interest rate on your home loan, you will have less interest to deduct on your income tax return. That, of course, may increase your tax payments and decrease the total savings you might obtain from a new, lower-interest mortgage.

You should be aware of an Internal Revenue Service (IRS) ruling with respect to points paid solely for refinancing your home mortgage. IRS regulations require that interest (points) paid up front for refinancing must be deducted over the life of the loan -- not in the year you refinance -- unless the loan is for home improvements. This means that if you paid a certain number of points, you would have to spread the tax deduction for those points over the life of the loan. If, however, the refinancing is for home improvements -- or a portion of the loan is for this purpose -- you may be able to deduct the points -- or a portion of the points -- under certain circumstances. Check with the IRS regarding the current rulings on refinancing, particularly if you are using the new loan to make home improvements.