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Weigh pros, cons when considering refinancing

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Q. I understand that mortgage interest rates are at their lowest in several years. Should I refinance my mortgage?

A. Rates are hovering around seven percent for a 30-year, fixed-rate mortgage. That's pretty low. Refinancing can lower your monthly payments, consolidate higher-interest debt, free up money to invest in other types of assets or pay off the loan sooner to save you thousands of dollars in interest.

However, that doesn't mean that everyone should automatically refinance. And the decision isn't just whether to refinance, but how to refinance. Each homeowner should run the numbers with the help of their financial advisor.

Q. Doesn't the rule of thumb say you shouldn't bother to refinance unless the new interest rate is at least 2 percent below your existing loan rate?

A. Yes, but it may pay to refinance even if you only save 1 percent or less on the rates, This is especially true now, with many lenders cutting closing costs, and in some cases offering no-cost refinancing.

Q. Explain the costs to me.

A. Closing costs can include credit checks, appraisals, title search, attorney fees, and points (each point is 1 percent of the amount of the loan). Some lenders forego some or all of the closing costs, but they will charge a higher interest rate. Consequently, even though one lender's interest rate might be lower than another's, it's not necessarily a good deal. Closing costs and interest rates vary from lender to lender, so you need to shop around. Also, some states charge "mortgage taxes" that can add 2 percent to the mortgage amount.

Q. Sounds confusing. How do I know whether it's worth refinancing?

A. It depends on several factors.

The longer you plan to live in your home after you refinance, the better. That gives you time to recoup refinancing costs and begin to save real money. Before deciding to refinance, you need to determine the number of months or years it will take you to reach that break-even point.

?Generally, the larger the loan being refinanced, the less time it will take to break even since the savings will be greater in proportion to the fixed closing costs. However, "jumbo" loans over $207,000 carry higher interest rates, which stretches out the break-even point.

?The lower your tax bracket, the more attractive refinancing. That's because most homeowners can deduct their mortgage interest on their tax returns. Refinancing means that savings from the lower monthly payment is partially offset by the resulting smaller tax deduction. However, homeowners in the lower tax brackets lose a smaller percentage of tax benefits than homeowners in higher brackets.

?The more points you pay up front, the lower the interest rates. The longer you plan to be in your home, generally the better this strategy.

?The length of the loan. If you stretch out your existing loan when you refinance, you may actually end up paying more in total interest even with a lower interest rate.

?Whether there is a prepayment penalty on your existing mortgage.

Q. Should I consider getting an adjustable rate mortgage (ARM) instead of a fixed?

A. Generally, this works only if you plan to move in three or four years and if you can save more in the first year than the total cost of refinancing. ARM rates typically are lower in the first year or two than fixed rates, but are likely to jump up after that.

Q. Should I refinance to pay off other existing debt, such as credit cards?

A. That's a consideration, but be aware that you're putting the investment in your home at greater risk, especially if you don't change the spending habits that ran up credit-card and other existing debt in the first place.

You also may put more than your home at risk by refinancing. Some states, such as California, allow lenders to use only the home itself as collateral in the event of a default on the first mortgage. But if the mortgage is refinanced, the lender can look to all of your assets in the event of default.

(The preceding article was produced by the Institute of Certified Financial Planners and provided by William O. Woody, CLU, ChFC, CFP, of Stovall Woody Associates.)

INSET CAPTION:

It may pay to refinance even if you only save 1 percent or less on the rates. This is especially true now, with many lenders cutting closing costs.[[In-content Ad]]

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