Before You Redo Your Loan, Do the Math

As September approaches, students’ thoughts inevitably drift to back-to-school matters. The rest of us ponder refinancing.

For those who have not yet refinanced during this period of record-low mortgage interest rates or are thinking about refinancing again, consider whether it’s prudent to do so, mortgage experts say.

It turns out that in some cases, it’s actually better to stick with what you have.

“I’ve been speaking to three people a day who shouldn’t refinance,” said David Soleymani, managing director of First Capital Corp. in Santa Monica. “A lot of people are not generating enough savings to offset the cost of refinancing. It’s important to do the math.”

Say your current $100,000 loan is at the fixed rate of 7%. Your mortgage payments are $665 a month. If you refinance now, at about 6%, the monthly payment would be $599. After taxes, monthly savings come to about $42.

If you refinance with zero points, and just pay the closing costs--typically $2,500--and divide that by the $42 you’re saving each month, it will take five years to break even on the money you spent for the new loan. To make this refinancing worthwhile, you would have to make sure you are staying in the house for at least five years.

“If you’re moving up in three or four years, refinancing is just not worth it,” Soleymani said. “And the smaller the loan, the harder to justify the refi.”

What about borrowers who already have refinanced, but want to inch a bit lower before rates go up? Those who one year ago refinanced a $200,000, 30-year fixed-rate mortgage at 7% interest would save only $70 or so a month in lower payments with a rate of 6.5%, for example, not much savings if you factor in closing fees, lenders say.

The one exception to that rule of thumb is homeowners who are paying private mortgage insurance, said Tom Swanson, a regional sales manager for Wells Fargo Home Mortgage.

Mortgage insurance usually is required if the home’s equity is worth less than 20% of the property’s value. The typical American last year gained nearly $10,000 in additional equity. That gain could, in some situations, save about $100 a month in insurance fees, making the refinance worthwhile.

Homeowners who already are more than halfway through with their payments--more than 15 years into a 30-year loan--are advised not to refinance, however, unless they’re still paying a rate of about 9%.

By signing on for another 30 years, the borrower will increase the amount of interest paid over the life of the loan, said Doug Duncan, chief economist for the Mortgage Bankers Assn. of America.

But if that borrower simply cannot resist today’s low interest rates, Duncan recommends switching to a 15-year loan, which typically features lower interest rates but higher monthly payments than 30-year loans.

Borrowers who don’t want the higher monthly payments--and therefore refinance with another 30-year loan--still can pay off the new loan in 15 years if they religiously make an additional payment on the principal each month, said Dan Weiss, a mortgage broker at Golden State Lending Services in Toluca Lake.

Weiss cautioned, however, that “they won’t save any money on the transaction if they use the extra cash every month on movies” instead of higher payments.

Finally, homeowners whose loans include a prepayment penalty are strongly cautioned not to refinance.

Typically, prepayment penalties are six months’ interest on the original loan balance. So if the original loan was for $250,000, penalties would run about $15,000.

The borrower also will have to pay about $2,500 in loan and escrow fees, way too steep a price to refinance, experts say.

“More and more loans have prepayment penalties today,” Weiss said. “Lenders are trying to discourage borrowers from refinancing over and over again.”