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Is it time to stop refinancing?

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When mortgage rates dropped below 5.5 percent, just about everyone who could refinance hopped on the bandwagon. But rates continued to drop, shattering record after record, and homeowners who refinanced just months ago are considering doing it again.

Is serial refinancing just silly?

According to the Curious Capitalist, refinancing too often can set back wealth-building in a big way, because every time you refinance, you begin paying your mortgage all over again. In the early years of a mortgage, the lender gets the bulk of the payment as interest. Author John Curran contends that restarting that process is, in his words, "a loser's game."

However, if you recently refinanced, and are considering it again, you won't be extending your mortgage term by much, and furthermore, your mortgage restart can be offset by additional principal payments if desired. However, refinancing does involve costs, and each refi can be expensive, so you want to be judicial about replacing your mortgage with a new one. A little number crunching can get you the right answer.

How often is too often when refinancing?

That depends on the cost of the refinance versus the savings realized by improving your mortgage terms. The costs of refinancing include:

  • Closing costs (such as appraisal fees, lender charges and title insurance). Note: if you recently refinanced, you should be able to get significant discounts on your title insurance (this is called a "short-term rate"). Items that you may be charged, like prepaid taxes and insurance, don't count as refinancing costs. These are costs of homeownership that have to be paid whether you refinance or not.
  • Extra interest. Every time you refinance, you re-start the clock on your mortgage amortization. If you have been paying on a 30-year fixed loan for five years, and then refinance to a new 30-year fixed mortgage, you'll end up paying on your mortgage for a total of 35 years. The total interest paid for the first five years and then the last 30 may well exceed what you would have paid had you chosen not to refinance.

The savings of refinancing can take two forms:

  • Lower monthly payment. The savings on your monthly payments are derived from stretching out your balance over a new term, and paying a lower interest rate.
  • Principal reduction. Additional reduction in principal is created when you select a mortgage with a shorter term and a lower rate. For example, when you refinance from a 30-year mortgage to a 15-year term.

Use a mortgage amortization calculator to compute the savings

In June 2009, 30-year fixed-rate mortgage rates nationwide averaged 5.92 percent at a cost of .13 points, according to HSH.com's mortgage statistics. In September 2010, the best mortgage candidates were being quoted as low as 4.25 percent with discount points, and a quick check with several lenders turned up current mortgage rates of 4.75 percent with no lender fees. So if you refinanced a $400,000 balance a year ago at the average rate of 5.92 percent, your payment would be $2,378 and your balance today would be $395,014. Assume that you plan to keep your home another five years and wish to see if it makes sense to refinance again.

Using the HSH.com mortgage calculator and inputting a mortgage balance of $400,000 and a rate of 5.92 percent, you can see that at the end of year six (five years from now), you'd have a mortgage balance of $365,149. Then, put in your current mortgage balance of $395,014 and a rate of 4.75 percent. Five years from now, your mortgage balance is $361,431. So refinancing would get you an additional principal reduction of $3,718.

In addition, your payment at 4.75 percent is $317 a month less than at 5.92 percent. Multiply this by 60 months (the five years you expect to retain the property) and you get a payment savings of $19,020, for a total savings of $22,738.

Assuming that you get a discount on your title insurance and pay refinancing costs of $2,500, your total savings from this refinance are $20,238.

Swapping a 30-year fixed for a 15-year

Can you tell how much a 15-year refinance will save over your current 30-year loan even though your monthly payment increases? Of course you can. While the payment savings generated by a higher payment will be negative, savings from the higher principal reduction offsets this. Remember also that 15-year mortgage rates are about half a percentage point lower than 30-year rates. So, if you could refinance your $395,014 balance to a 15-year loan at 4.25 percent for the same $2,500 cost, your five-year savings would look like this:

New loan payment: $2,972, some $594 higher than your old payment. Over five years, you'll pay $35,636 more towards this loan, which counts as negative payment savings. However, at the end of five years, your balance is $290,089 -- $75,059 lower than it would be without a term-shortening refinance. So this refinance saves you a total of $39,423 ($75,059 - $35636) over five years. Subtract the $2,500 in costs and you get $36,923.

Your decision ultimately depends a great deal on the length of time you expect to keep your property, as well as the terms and costs. Get a few mortgage quotes and then use an amortization calculator to see if today is a good day to refinance.

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