When to Refinance, When to Sit Tight

If the news about the national mortgage meltdown has you thinking that refinancing is a bad idea, think again. Interest rates for 15-year and 30-year fixed-rate loans still hover near historic lows. And although banks have tightened their restrictions, applications are still getting approved.

Whether you are facing payments that you can no longer afford or you want to take advantage of these low rates, refinancing may well be on your mind. Here's how to figure out if it is right for you.

Look at the Short-Term Savings

As with a regular mortgage, refinancing involves closing costs. Lenders are required to provide you with a good-faith estimate of those costs before closing. But it's common for a few last-minute changes to boost the overall tab. Don't forget about the prepayment penalties that may apply to your existing mortgage, particularly if you're holding an adjustable-rate mortgage. Although the use of prepayment penalties may eventually be abolished, or at least severely curtailed, they are still in effect for many borrowers.

To calculate how long it'll take for your monthly savings to pay off the costs you'll incur by refinancing, add up your closing costs and any additional penalties. Then divide that number by the savings from your new monthly mortgage payments. The resulting figure is the number of months before you break even. So if your closing would cost $2,500 and refinancing would lower your monthly payments by $85, you'd hit your break-even point in 29.4 months. In that case, if you think you might move in the next two-and-a-half years, then refinancing is probably not a good idea.

But, don't give up hope just because the first set of numbers doesn't work out. Ask your loan officer to run the numbers for different types of loans to see if you can find one that's right.

For example, if you know you will move in just a few years but the rates on your existing ARM are about to skyrocket, refinancing with a new ARM may very well make sense.