Q. Is refinancing a mortgage worth it?
A. You may think of your house as an investment. Unfortunately, you probably won't see the return on that investment until you're loading up the white Cadillac for the big move to Sarasota. There's a more-immediate way you may be able to make some money off your house, though: refinance your mortgage.
Refinancing is when you take out a new mortgage on your home, at a lower interest rate, decreasing the amount of your monthly payments. In some creative refinancings, you can actually increase the amount of the loan for such Foolish pursuits as paying down credit card debt or making improvements to your home. (Keep in mind, however, that your house is the collateral on the loan. If you don't keep up with your payments, you could find yourself homeless.)
Mortgage interest is tax-deductible, so to calculate the effective yield of a mortgage, multiply the interest rate by your tax bracket. Then subtract that from your interest rate. Investors in a 33% bracket with a 7.5% mortgage interest rate, for example, are effectively paying a 5% mortgage interest rate (7.5 x .33 = 2.5; 7.5 - 2.5 = 5.0).
Your first step is to assess the myriad mortgage costs involved -- such as origination fees, discount points, the appraisal, the credit report, processing, title insurance, and the escrow fee.
Next, check out available loans and interest rates (made easy at websites like www.bankrate.com). Consider what "points," if any, you might have to pay. A point is equal to 1% of the value of your loan. It's paid up-front when you close the loan.
If you find a rate that is lower than your current rate by one or even half a percentage point, that can result in whopping interest savings over 15 to 30 years, depending on how much you borrow. For example, $100,000 borrowed at 7% instead of 8% for 30 years will save about $25,000 over the length of the loan. If you invest the extra $69 a month in the S&P 500, at the S&P's historical 11% annual return, in 30 years you would have roughly $180,000.
On the other hand, if you don't plan on being in your current house for that long, the money you'll spend getting the loan (points, fees, etc.) may consume the money you'll save by getting a lower mortgage payment. Therefore, you should crunch some numbers to see if refinancing makes sense right now. You'll find guidance and more information in our Home Center and in this article on refinancing.
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This question and answer is adapted from The Motley Fool Money Guide: Answers to Your Questions About Saving, Spending and Investing. For answers to this and 499 other common money questions, check it out -- it's a handy resource.
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