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Should You Refinance?

This article is part of our Subprime Survival Guide.

Everybody's doing it -- or at least, it sure seemed that way a few years ago. I'm talking about refinancing your mortgage. It made a lot of sense in the past, especially when interest rates dipped into record-low territory. But now that interest rates have been inching up, does it still make sense? Here are a few thoughts.

If you just never got around to refinancing in the past few years, you shouldn't think you're out of luck just because interest rates rose a bit. They're still very low, relatively speaking.

Remember that when you refinance, you can get more than a new interest rate; you can get a whole new mortgage. In other words, you can exchange one for another that offers better features. Don't like your 15-year mortgage? Refinance into a 30-year one. Don't like your adjustable-rate mortgage (ARM)? Refinance into a fixed-rate one.

Given these perspectives, it should be clear that even in an environment of rising rates, refinancing can sometimes make sense. Still, there are more factors to consider:

  • The overall bottom line is that refinancing makes sense if, when you crunch the numbers, you end up paying less with the new arrangement. (Or if your new mortgage is more compelling in a way that's worth any extra cost.)

  • If you have an ARM, refinancing can be smart amid rising rates. Adjustable-rate mortgages will adjust your rate regularly as rates rise, hitting you with ever-bigger payments. A fixed-rate monthly payment, locked in now, may be higher than your current ARM rate, but it might be considerably lower than the ARM payment you'll face in two or three years. In the long run, the fixed rate could be the better deal.

  • You might even want to replace your ARM with another ARM. Since ARMs tend to have fixed low rates for their first few years, if you're already a few years into your ARM, you could essentially "reset" it, starting a new clock, by getting a new ARM. If you're pretty sure you won't even stay in your home for too many years, locking in a new fixed-for-a-few-years low rate with a new ARM could be smart.

The math
I can't end this article without reviewing the math basics behind traditional should-I-refinance calculations. In a nutshell, here's how to think of it:

  • Calculate how much your monthly payment will be with a new mortgage you're considering. (You'll find some help in our calculator nook.) Subtract this amount from your current monthly payment. Let's say that you'll be saving $150 per month.

  • Next, figure out what your closing costs will be -- or, more thoroughly, what it will cost you, in total, to refinance. Beware of any "no-fee" refinancing offers, because there can still be some costs tucked into other areas -- such as a higher borrowed sum, a higher interest rate, etc.  Let's say your refinancing cost would be $2,000.

  • Divide the refinancing cost ($2,000) by the monthly savings ($150), and you'll end up with the number of months it will take until you break even -- in this example, it's 13.3. If you sell the home within about a year, you'll have refinanced in vain. But if you plan to keep the home for longer than that, you'll come out ahead.

Learn more
If you're interested in homebuying and -selling issues, visit our Home Center, which features lots of money-saving tips on mortgages and other issues. You might also want to check out these articles, especially if you'll soon be buying a new home:

Longtime Fool contributor Selena Maranjian appreciates your feedback.


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Selena Maranjian
TMFSelena

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter...

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