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Should you refinance?

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Mortgage rates have been falling for months now, and the 2011 refi boom is underway. But how do you know if refinancing is right for you? You can come across hundreds of thousands of responses to the age-old question of "Should I refinance?" Yet unfortunately, too many mortgage experts are giving out the wrong advice.

Refi Boom

Not only will I tell you how to properly answer the question of "Should I refinance," I will tell you how to do it for little or no cost.

Why do homeowners refinance?

Plain and simple, when mortgage rates are falling, homeowners like to refinance. A well-executed refinance can lower your interest rate, lower your monthly payment and help you pay off your home more quickly.

However, knowing when to ask for a refinance is not always so clear. Mortgage rates change all the time, and factors such as closing costs and loan re-amortizations can really change up your overall costs and potential savings.

Should you refinance?

If you were to go to Google for help, you would be inundated with more than 675,000 answers to your simple question of "Should I refinance?" That is an overwhelming amount of websites full of experts and advice to sort through, without any guarantee that you will get a fair answer.

Unfortunately, most of the websites and online "mortgage gurus" treat your question of "Should I refinance" with the same flawed logic.

Here is what they will tell you to do:

  • Step 1: Calculate your monthly savings with the refinance
  • Step 2: Calculate your total costs of refinancing
  • Step 3: Divide your savings into your costs to find your "break-even" point (in months)

For a real-life example, if a refinance will save you $75 per month (Step 1) and cost you $3,000 (Step 2), your break-even point is 40 months (Step 3).

So far, so good. It is the recommended "Step 4" where the mistakes get made.

Flawed refi logic

According to the experts, once you have calculated your break-even point, choosing whether or not to refinance is easy. If you plan to live in your home longer than the break-even point, say "yes" to the refinance. Otherwise, say "no."

In a vacuum, this logic works. In the real world, however, it fails.

3 reasons why their logic fails

  1. The logic assumes that mortgage rates stay constant over time. They do not.
  2. It assumes that you know for certain for how long you will live in your home. You do not.
  3. It does not account for the unrecoverable costs of a refinance (which are typically added to your loan balance on which you pay interest). These costs can be high.

Simply calculating your break-even point is irrelevant because the formula is too self-contained. There is a much better way to approach your refinance.

Here is how to make a better refinance decision

When you are ready to refinance, you cannot control your mortgage rate; that is a mortgage market function. However, since you can control your closing costs, that is where you should focus your attention.

When possible, look for a zero-cost refinance

A zero-cost refinance is exactly what it sounds like--it is a refinance for which you pay zero closing costs. But do not confuse "zero cost" with "free." There is a cost.

In exchange for having your closing costs waived in full, your lender will ask you to willingly accept a mortgage rate that is slightly higher than today's "going rate."

That increase in rate could be as small as 1/8 percent, or as high as 3/8 percent. The net effect is that you will pay a little bit more each month in interest, but you will not have to pay a dime upfront to your lender.

No closing costs=No break-even point

For most people, this arrangement is perfect. It limits their unrecoverable costs to $0, it preserves all of their home equity, and it eliminates the flaws of the "break-even conversation." There is no break-even point when there are no closing costs.

Should you refinance?

If you can save money with no costs, say "yes."

You start saving money immediately. Plus, when mortgage rates fall again, you can apply the same logic without having to consider the money you paid to refinance the last time.

Most lenders will give you a zero-cost option--just make sure you ask for it.

About the author:

Dan Green is a loan officer with Waterstone Mortgage in Cincinnati, Ohio, and the author of the nationally recognized mortgage blog, TheMortgageReports.com. Dan lends in most states and offer zero-cost mortgages to his purchase and refinance clients. Follow him on Twitter at @mortgagereports.

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