Tuesday, April 7, 2009

When is it the right time to refinance?

By: Tsu-Han (Ina) Chang

It depends. Refinancing requires an in depth analysis on the part of the homeowner. First, what is refinancing? It is the exchange or replacement of the current mortgage/debt to an alternate loan with different terms and conditions. In the case of refinancing a home mortgage, the homeowner is looking to change their current debt obligation based on the market’s latest interest rates as well as personal choices they have made. Therefore, it is important for the homeowner to evaluate the pros and cons of refinancing using cost benefit analysis.

The cost benefit analysis involves the homeowner to list out the reasons for refinance. For example, better interest rates to lower the monthly payment, desire for home improvements, paying for college education/tuition, or even to liquidate parts of the value of the home in order to have more cash on hand for emergencies. Due to the variety of reasons a homeowner may choose to refinance it is best for the homeowner to evaluate the cost and benefit of the refinance. For example, a homeowner has decided that since there is a 1% drop in the interest rate they would like to refinance. However, although a 1% drop on a $300,000 mortgage may seem like a lot, the closing costs alone may costs about 1% of the mortgage loan amount. And, if the homeowner wants to move within a short amount of time; less than five years, the technically the “savings” on the monthly payments under the new and lower interest rate, would not have been worth it. This simple example only took into consideration better rate in the current market. However, by looking at the cost to refinance, it can already be assumed that the homeowner should not refinance. Therefore, it is important to complete an in depth cost benefit analysis when looking to refinance, because there are many details to be considered when refinancing.

Important questions to ask when considering refinancing are:
1. Is the interest rate at least 2% lower than the rate I currently own? (2% is a good rule of thumb to use)
2. What are the terms of the new loan? How long will it take for it to be paid off? How long to I plan on keeping the home?
3. What kind of loan will I be getting? What kind of loan am I looking for?
4. What are the costs to refinancing? Closing costs, opportunity costs/alternate investment possibilities that may yield a higher return?


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