Chapter 9: How To Refinance Your Mortgage
How to Refinance Your Mortgage
The process of exchanging a current mortgage for a new one is called refinancing. You may want to consider refinancing in order to:
1. Adjust the variety of loan: You may find that, as your situation changes, the variety of mortgage that you have no longer fits your needs. For example, you may have an ARM and are uneasy about the increased interest rates that will result at the conclusion of your fixed-rate stage, you could choose to refinance your ARM to a 30-year fixed-rate mortgage. In the case that you already have a 30-year fixed-rate mortgage, you may choose to refinance to get a 15-year fixed-rate, which would allow for a sooner pay off of the loan and reduce the whole sum of interest that you have to pay.
2. Cut costs: If interest rates have decreased considerably from the time you acquired your loan, it is likely that refinancing could lower your monthly payments along with reducing the interest that that you pay over the span of the mortgage.
3. Cash out: In the event that you refinance and get a loan that surpasses your prior loan balance, You will be provided with a cash “reimbursement” equal to the discrepancy between your initial loan balance and the new loan balance. This cash reimbursement can be used in any way that you choose, however, some lenders charge higher rates for new loans to borrowers that are refinancing for this specific reason.
Should You Refinance Your Mortgage?
It is wise to reference the 2% rule when trying to decide if you should refinance your mortgage. The 2% rule asserts that refinancing is only sensible if you are able to get a rate that is a minimum of 2% lower than that of your current rate.
Although the 2% rule is useful, it is not absolute. It is more thorough to figure the length of time it would take for the after-tax monthly funds to cover the cost of your refinancing expenses (these are generally equal to the closing costs from your initial loan). To figure this information
1. Calculate the monthly pretax reduction, the “rough” difference between the monthly payment you are currently paying and the amount of your new monthly payment. In this case, assume your current payment is $699.21 (a $100,000, 30-year fixed-rate mortgage with an APR of 7.5%) and a new payment equal to $599.55 (the same loan with an APR of only 6%). The pretax monthly reduction would equal $699.21 – $599.55, or $99.66
2. Calculate the after-tax monthly reduction. In order to do this, multiply the pretax reduction by (1 – your federal income tax bracket). In this situation, we will assume a tax bracket of 28%, so you would multiply $99.66 by (1 – 0.28), which comes out to $71.76.
3. Divide your refinancing costs (we’ll use $3,000 for this example) by the after-tax monthly reduction. In this instance, you would divide $3,000 by $71.76, which is 42. The resulting number (42) is the quantity of months that it would take for your after-tax reduction to cover the cost for refinancing. It is only after the reduction has covered your closing cost that your refinance will begin to save you any money.
According to the 2% rule, it would be unwise to refinance in this circumstance, because the difference between the rates of the current and prospective loans is only 1.5%. However, the more exact after-tax reduction calculation illustrates that refinancing does make sense if you plan to keep the new loan for more than 42 months.
Tax Deductions for Refinancing Costs
Different from the closing of your initial mortgage, you are not allowed to deduct all refinancing costs from your taxes at one time. However, you can deduct the charges; the deductions just have to be extended across the lifetime of the loan. This means that the tax benefit savings can only be taken gradually and in slight amounts.
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