Should I Refinance my Home?

With interest rates at historic lows, many homeowners are choosing to refinance to lower their interest rate. Lowering your interest rate will help you save money on your loan, lower your payments and possibly allow you to pay off your debt sooner. You can use an online calculator  to see your possible savings. However, refinancing your mortgage is not as clear cut as the TV advertisements may make it sound.

While the allure of saving money on your loan may cause you to run to your nearest mortgage lender, it is important to remember that a refinance can be as stressful as the first time you applied for the initial mortgage on your home. In order to ensure the lowest interest rate, you want to make sure your credit score  is as high as possible. Secondly, when refinancing your loan, you will have to pay closing costs again, which can add up quickly and negate any savings. Out of pocket costs such as a home appraisal, lawyer fees and application fees soon may negate the savings of the lower interest rate.

Another reason that a homeowner may decide to refinance is to use the equity in their home to complete a large home project or to consolidate debt. This type of refinance is called a “cash-out” refinance because you take out more money than you owe on your home in order, leaving you with extra money in your pocket.  A “cash out” refinance is beneficial for those homeowners who are looking to complete a project that would add significant value to their home or to consolidate their other debts to pay them off faster with a lower interest rate.

But taking out extra money to do upgrade a home is risky, because you could end up owing more to the bank than your upgrade is worth. So you should be very confident of the project. If you use the extra money to pay off other debts, you could end up losing your house if you fail pay off your new, larger mortgage. In contrast, many states have homestead rules that protect some house equity from creditors for non-housing debt.

When sitting down to make the decision on whether or not a mortgage refinance is right for you, it is important to know the facts about both your current and future loan. A simple chart will make comparison simple. Factoring in the closing costs and the down payment required for the refinance is essential to see if refinance is worth it. Can you afford to put the money down? How much will you be saving on a monthly basis?

In many cases, a refinance does not cover the additional fees unless you plan to be in your house for several years. For example, if your new down payment and closing costs total $5,000, but you only save $100 in Monthly Payment, then you need to be in your office for at least another 50 months, just to recoup those fixed costs. But refinancing can be a money saver if done under the right conditions.



Kent Smetters

Kent Smetters is the Boettner Chair Professor at The Wharton School of the University of Pennsylvania, the Interim Faculty Director of the Penn Wharton Public Policy Initiative, and a Faculty Research Fellow at the NBER. He was the former Deputy Assistant Secretary of the U.S. Department of the Treasury, and he subsequently served as a member of the U.S. Congress’ bipartisan Blue Ribbon Advisory Panel on Dynamic Scoring. Kent holds bachelor degrees in Economics and Computer Science from The Ohio State University as well as an MA and PhD in Economics from Harvard University. He previously cofounded a national registered investment advisory firm that built a new technology platform, grew the firm to over 50 advisors and then sold the firm to a large, publicly-traded company. Growing up in a financially poor family, Kent donates his time to “Your Money” to help families work, save and set goals in order to achieve the most in life. Kent is often cited in major news outlets.