Should I Refinance?

I often get this question when screening questions from prospects or during financial planning workshops. Like so many personal finance questions, these are unanswerable without more information provided by the questioner.

Should I retire?
Should I get married this year?
Should I exercise my stock options?

These contingent questions are useless when no additional information is provided. So, “should I refinance?” is a loaded question for me because a mortgage refinancing strategy can have a variety of purposes, and that the success of your refinance depends on a range of factors that vary with your purpose.

Let’s look at five good reasons to refinance your mortgage:

1. Lower your Interest Cost
Most borrowers contemplating the refinance of a fixed-rate mortgage want to know whether the financial gain from a lower interest rate more than offsets the refinance costs. This is less important as a motivation than it was a year ago because of the rise in rates that has since occurred. It remains relevant, however, to borrowers with older higher-rate mortgages who for one reason or another failed to refinance when rates were at their lowest.

It’s important to run the numbers to measure the benefits of a rate-reduction refinance relative to the refinance costs. Whether you have one mortgage that will be refinanced into another mortgage, have both a first and a second mortgage that will be refinanced into one new mortgage or have one mortgage carrying private mortgage insurance and will be refinancing into a combination first and second mortgage without mortgage insurance.

2. Liquidity – I need to Raise Cash

Another reason borrowers refinance is to raise cash. While cash-out refinances are priced higher than rate-reduction refinances, this is not in itself a deterrent to the borrower who needs cash. What matters to that borrower is whether the cost of the cash-out refinance is larger or smaller than the cost of raising the same amount of cash with a second mortgage.

3. Risk Management – Reduce the Risk of Higher Rates on an ARM

Borrowers who now have an adjustable rate mortgage (ARM) and are concerned about rising interest rates have their own reason for considering a refinance. They want to know whether the likely loss from retaining their ARM exceeds the cost of eliminating the risk by refinancing into a fixed-rate mortgage.

4. Cash-in Refinance

Some borrowers have mortgage interest rates above the current market but they can’t refinance into a lower rate because their house value has depreciated. They want to know whether paying down the balance on their existing fixed-rate mortgage in order to lower the cost of refinancing into another fixed-rate mortgage would yield a satisfactory rate of return.

5. Eliminate High-Cost Short-Term Debt

Borrowers who are burdened with short-term debt may want to know whether it pays to consolidate such debt in a cash-out refinance. Here the borrower is comparing the cost of consolidating the short-term debt in a new and larger first mortgage, or in a second mortgage.

Don’t make assumptions or rely on a generalized rule of thumb. Instead run the numbers and see if the refinance will actually improve your balance sheet or cash flow.

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