Factors to consider before refinancing

Last week’s column urged us all to examine our current home loan to see if it would be beneficial to refinance. Here are some questions that frequently arise whenever refinancing is the subject:

Q I have always heard that refinancing isn’t a good idea unless you can drop your interest rate by at least 2 percentage points. Is that true?

A Like many rules of thumb, it can be true but not always. The best way to decide on refinancing is to talk with a mortgage lender and let them explain the products they have available and how they can save you money. Short of that, here is my quick- and-dirty analysis:

> Determine how much it will cost you to refinance. Typically, closing costs are in the range of 2.5 percent of the new loan amount but sometimes less, depending on the rate you accept. Talk to your lender.

> Determine the annual savings. Multiply your loan balance by your interest rate to determine the savings.

> Multiply the amount of savings by the number of years you expect to own the property. That is your expected savings amount. If the expected savings substantially exceeds the cost of refinancing, then it is likely worthwhile to proceed. If not, you can seek to lower your closing costs by accepting a slightly higher interest rate.

How can a lender afford to offer a “zero closing cost” refinance program? Who actually pays for the expenses?

If the closing costs are below about 2.5 percent of the loan, then the lender is absorbing the costs internally. In exchange, you will be offered a slightly higher interest rate, which the lender can sell for a slight premium after closing. In other words, you are actually paying for your closing in the rate you accept.

My interest rate is high at 8 percent, but I only have nine years left before my loan pays out. Should I consider refinancing, and if so, won’t it cost me a lot more in interest over the extended payback period?
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