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Numbers need to add up before you refinance

WASHINGTON -- Recent dips in interest rates may have homeowners wondering whether it's time to refinance their mortgages.

Refinancing can make sense for many people, but the decision should take into account more than swings in market interest rates, consumer-finance experts say.

"It is a lot more complicated than it used to be," said Holden Lewis, Bankrate.com's senior reporter specializing in mortgages. Until recently, he said, people refinanced for three main reasons: to get a lower rate, to get rid of private mortgage insurance premiums, or to pull out cash to consolidate bills or pay for big-ticket expenses.

Now, he said, owners frequently are motivated by a fourth reason: changing the type of loan they have. Perhaps their adjustable-rate mortgages are scheduled to reset soon and they are worried that their interest rates and payments will rise.

In other cases, they are worried about ARM resets that are years away, thinking that a decline in their house's value could keep them from being able to refinance then.

"I think it's a real fear out there," Lewis said. "People are in risk-management mode, instead of just simple math mode."

That math is indeed pretty simple, but the calculation must be made specifically for your mortgage, said Ted Toal, a certified financial planner with Triton Wealth Management in Annapolis, Md. "Just because rates have dropped, don't feel pressure like you have to refinance," he said. "Take a look at your current loan, do the math and see if it makes sense."

The math starts with the interest rate on your loan, Toal said.

Is the rate higher than what you would qualify for today? Toal said many people who bought or refinanced three to four years ago have "very good rates," but that those who bought in the past year or two might benefit from refinancing.

Keep in mind that individual factors, such as income, credit scores and equity, also will influence the rates for which a person qualifies. That could benefit homeowners whose circumstances have improved significantly since they took out their loans, but it could be an obstacle to refinancing for those who are struggling.

Prospective refinancers also will find that rates vary depending on how much they borrow and over what term. For example, a 15-year mortgage generally comes with a lower interest rate than a 30-year one. The monthly payment may be bigger, but the savings over the life of the loan can be significant.

The next factor to consider is whether there are any upfront closing costs, such as origination fees and points. Those can vary significantly among loans; many lenders offer no-cost refinancing, in which fees are rolled into the interest rate.

Toal said borrowers should be cautious about adding closing costs to a loan balance.

"It's better to pay the closing costs out of your own pocket rather than rolling them up into the loan," he said. "Financing that expense over 30 years with interest is not a good idea."

Next, look closely at the paperwork for your loan and see if you will owe a prepayment penalty if you pay that loan off early.

Once you know how much the refinancing would cost you out of pocket and how much you would save monthly with the new interest rate, use those two numbers to determine the break-even point -- the date that the monthly savings equal the costs associated with refinancing, Toal said.

What's a reasonable length of time for that break-even point? Stuart McHenry, a certified financial planner with Open Heart Financial in Waldorf, Md., said it depends on how long a person intends to keep the mortgage. Two years is his general guideline for breaking even.

"And if a person can recoup the costs instantly by doing a no-cost refi, then that's obviously attractive," McHenry said.

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