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How to Make the Most From Refinancing

For most homeowners, mortgage payments dwarf all other living expenses. When an opportunity comes to reduce those payments, many jump at it. Some homeowners, however, jump a little too quickly. When you're bombarded by ads from mortgage lenders day after day, it's easy to understand why.

Focusing solely on how much you can save from refinancing is tempting. Yet research done in the early 2000s by economists from Harvard, Brown, FleetBoston Financial, and the National Bureau of Economic Research suggests that this common decision-making process for whether to refinance is too simplistic. By using a more sophisticated model, they argue that waiting for bigger savings is better for most borrowers in the long run.

Turning down free money
In evaluating the benefits of refinancing, financial planners often compare the expected reduction in monthly payments against the costs associated with refinancing. When the amount saved exceeds the costs by more than a tiny amount, planners will often recommend that homeowners replace their current mortgage.

It's hard to argue against saving money. But by focusing on how much you can save, the paper concludes that a surprisingly large number of mortgage borrowers -- nearly a third -- save less than they could by refinancing too early. These results fly in the face of those who say that many borrowers wait too long before they refinance their mortgages, even when interest rates have dropped substantially.

Weighing the costs
The analysis hinges on the reality that refinancing costs money. If you could refinance for free, you could grab a few extra dollars every time interest rates experienced a small dip. But when you consider mortgage application fees, title insurance premiums, and other closing costs, you can't afford to refinance every day.

Because of that, the authors argue, you should be very careful when you decide to pull the trigger. For instance, if you could save $25 a month now, deciding to refinance may mean giving up the possibility of saving $50 or $100 a month if rates continue to fall. And although the paper cites many personal-finance experts who advise against trying to time mortgage rates in this way, the authors maintain that only by treating the refinancing option as a rational economic decision can you make the most from your mortgage.

Analyzing a number of factors, including the size of your mortgage, the length of time you'll stay in your home, and the volatility of interest rates, the paper concludes that the optimal time to refinance for those who intend to stay in their homes indefinitely is when rates have fallen 1%-2% from your existing mortgage. For those planning to move in the near future, rates may have to fall even further before it makes sense to refinance.

Look before you leap
This analysis of refinancing options serves as a reminder that many financial decisions are more complicated than they seem at first. It's smart to look for savings anywhere you can. But by jumping at the first opportunity to save small amounts, you could give up the chance to reap bigger savings later. 


Read/Post Comments (8) | Recommend This Article (54)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 05, 2009, at 6:40 PM, ccecalajr wrote:

    Anyone with a thought of how low rates will go!

  • Report this Comment On February 17, 2009, at 2:04 PM, BradTullinger wrote:

    My wife and I are looking to refinance our home soon. Thanks for the advice! This article was very helpful as well: http://www.loanbiz.com/mortgage-refinance/is-it-time-to-refi...

    Hopefully, we can figure this whole thing out and get the best rate!

  • Report this Comment On May 04, 2009, at 8:59 PM, skipthom wrote:

    Folks who are trying to deal with lenders should definitely check out www.LoanTactics.com.

    These past lenders share their insights into the dirty tactics used by people in this industry.

    They provide very insightful information for those trying to buy their first house, to those refinancing for the first or third time. It is truly incredible information.

  • Report this Comment On May 24, 2010, at 4:09 PM, wchildress wrote:

    Would someone enlighten me? Most people I know refi only for a lower rate. They neglect to shorten the term of their loan. Example: 500k at 5.3% for 30 yrs refi 5 years later refi ~$460 (balance of initial mortgage) at 4.3% for 30 yrs. Where is the savings? You will now pay the ~$129k interest from the first 5 yrs on the first and now ~$359k interest over the next 30. That is an additional ~$88k in interest. Does everyone refi just to lower monthly payments? Does anyone pay off their house?

  • Report this Comment On December 02, 2010, at 1:41 AM, flint5oh wrote:

    Another reason refinancing may make sense is if someone has income property. Refinancing to a lower rate will generally mean more money in the owners pocket every month. Yes, you are extending the life of the loan but someone else is paying for the principle and interest. Paying off the loan for an income property may or may not make sense. Each situation is different so its hard to make a generalization.

  • Report this Comment On March 25, 2011, at 12:25 PM, janeyburton wrote:

    Regarding w/ childress' comment: I wish I was given the advise years ago NOT to refinace, at least not at another 30 yr. loan. We have owned our house for 25 years. Because we have refinanced 4 or 5 times to lower the rate and once or twice to take money out for home improvements, we now owe exactly the same amount we owed 25 years ago and have 23 years left on the loan. Now we are ready to retire and still have 23 years left to pay.

    A lower rate is great, but if you continue taking out a 30 yr. loan the amortization starts all over.

    Anyone know of a good artle on figurig out where you are in the amortization schedule and if it really makes since to refinance?

  • Report this Comment On July 06, 2011, at 12:15 AM, BookCzar wrote:

    I personally Love all the doom and gloom. When there's blood in the water...right? The age old adage is that we should invest when no one else wants to. But why is it so difficult to do? How many of us bought Citi when it dipped under 1 dollar a few years ago?

    Real estate is definitely not like it was 4 years ago, but it is now a good opportunity again. With companies like www.capitalira.com now allowing for investing through an IRA, we are going to see an even larger market for real estate investing.

    I know there's a lot of reason to avoid real estate, that's why Im so interested.

  • Report this Comment On January 20, 2012, at 11:08 AM, gcor1952 wrote:

    One additional help that may come out of refi is that you have to get an appraisal of your house. The lender usually makes you do this. In a lot of cases the appraisal is lower than the market value the local assessor has on the property. You can take that appraisal to the assessor and have them lower your market value and therefore lower your property taxes. You may want to check the assessor's market value first just to make sure his value isn't lower than the appraisal. Usually it is not.

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