What You Should Know Before Refinancing

October 4, 2007
If you have an adjustable rate mortgage that's scheduled to reset in the coming months, it may be a good idea to think about refinancing -- but be careful! It's not always the best solution.

The most obvious benefit of refinancing your home is a lower monthly payment.

For example, the principal and interest on a 30-year $150,000 mortgage at 7.25 percent works out to $1,023. In contrast, your monthly payment for same loan at 6.25 percent is only $924.

While the thought of a lower payment is enticing, there are a few things to consider before signing on the dotted line:

• Refinancing costs money. The phrase no cost loan is used a lot in commercials, but may not be totally accurate. No cost loans will usually carry a slightly higher rate than a loan that does not pay your costs. In addition, you may still have to come out-of-pocket for incidentals such as credit reports and an appraisal.

• Not everyone gets the best rates. To get todays best rates, you have to qualify. Therefore, if you have less-then-perfect credit, you may want to improve your credit standing before you try to refinance. In addition, to get the best rates, youll need to keep your borrowing to less than 80 percent of the value of your home.

• Use your monthly savings wisely. Since you are already used to a higher payment, it is smart to use the difference to your best advantage. Some ideas might be to pay down debt or establish a retirement fund.

• Refinancing is not right for everyone. If you have a prepayment penalty on your existing loan or will not be in your home long enough for the savings to outweigh the costs, refinancing may not be in your best interest. In addition, if you are taking equity out of your home to pay down credit cards, but are concerned that you may charge again, this financial move could actually exacerbate your debt problems.

• Dont get caught at tax time. Most peoples largest deduction is their home mortgage interest and lower interest equals a smaller deduction -- and, therefore, a bigger tax bill.

Finally, you might consider refinancing a 30-year mortgage to a 15-year note, said Cate Williams, vice president of financial literacy for Money Management International. While you may not save as much on a monthly basis, interest rates are even more attractive for shorter loans and the amount you save in overall interest payments can be substantial.