One of the most misunderstood aspects of mortgage banking continues to be refinancing. “When Should I Refinance My Mortgage?” seems to be the catchphrase in a declining interest rate environment. “Wait until the rate drops 2% before you do anything” is one of the myths that circulate. “Make sure you find a lender that charges no closing costs” is another.

## When Should I Refinance My Mortgage?

## The Right Time To Refinance

#### The truth of the matter is that there is no easy answer.

Refinancing is an individualistic issue that comes down to a handful of questions. The questions are simple enough. It is the answers that create headaches. We will attempt to at least inform you of what the issues are so that when you consider your own options you will be better prepared, knowing that you are at least asking the right questions.

## What are the current rates?

The first question that you should obviously ask is “What are the current interest rates?” In most cases when refinancing, people will be interested in some fixed rate option, so they will gather information about 15, 20, and 30-year fixed-rate mortgages. 25-year mortgages almost always carry the same rates as 30 year fixed. If you are considering a 25-year mortgage, remember that you will not be saving any money on your rate and you will be strapped with higher payments. It is usually advisable to avoid the higher payments associated with the 25-year mortgage that would strap you in case you hit a medical or employment emergency during the term of the loan. You also need to make sure that your personal discipline on prepaying will not be an issue either.

## Should I consider an ARM?

In some exceptional cases, an adjustable-rate mortgage (ARM) may suit your needs. These exceptions may include having a very high rate on your current mortgage but believing that rates will be lower 3-5 years from now. The thought is that during that interim period you do not want to be tied down with a higher fixed rate. This can be precarious however since it involves trying to predict the markets and even the “professionals” struggle with that.

The other exception would involve knowing that you will be spending less than 8-10 more years in the house, but your current rate is much too high for your liking. In this case, you may look at a 5/1 or 7/1, or 10/1 ARM to carry you through and bring your rate down until you move. These types of adjustable-rate mortgages will allow the rate to be fixed for the initial term of the loan such as the first five, seven, or ten years. Afterward, the rate can adjust annually for the remaining term of the 30-year payout. As with any ARM, these loans carry caps to protect you against a very high-interest rate market after the initial term has expired.

## How does the new rate compare to my current one?

Once you have picked your product you then need to look at the zero-point rate on that product. (Discounted rates can be offered by paying upfront “discount points”. Each point is equal to 1% of the loan amount.) Some lenders may charge an “origination fee” of one point and claim that the loan carries no points since it does not carry any “discount points”. Any fee that is calculated as a percentage of the loan amount should be considered points.

Examining the zero-point rate allows for an apples-to-apples comparison with your current rate and enhances the accuracy of your decision. Once it’s decided if the zero-point rate is worthwhile, it can then be determined whether it’s additionally worthwhile to pay points.

Once the zero-point rate has been established, you will calculate the difference in rate and payment that will be experienced between your old mortgage and your newly refinanced one. This differential will be one of the foundations for your decision.

## What are my out-of-pocket costs?

After you have figured out your differential, you will then need to move on to predict what your “out-of-pocket” closing costs will be. Out of pocket costs are those costs that you would not have if you did not refinance.

The most basic way to describe this is the costs that would be in sections A, B, and C of your Loan Estimate plus your recording fees. They include costs charged to you by the lender, the title company, and your settlement agent (attorneys are not required in NJ for refinancing and are rarely used).

Title companies are the agencies that research and insure the title to a property. They will confirm that no previous title holder can come back and claim ownership. They will also ensure, in the case of a refinance, that no additional liens have been placed against the property since the last mortgage closing. These title searches, along with the title insurance, will generally account for a very good portion of your costs when refinancing. New Jersey title fees are regulated by the state and you can get a good idea of what your fees will be by contacting a local title company and asking for a quote.

Other closing costs include items such as the lender application fee, appraisal (if not waived), updated credit report fees, recording fees to the township, and closing and settlement fees.

## What other expenses are at closing?

Other “closing costs” which are listed in sections F&G of the Loan Estimate that should not play a role in your decision include:

#### Prepaid interest:

This is simply the interest that you will be paying from the day you close until the end of the month. In addition to prepaid interest, you will see accrued interest on your payoff from your old bank from the first day of the month through the date of payoff. These two types of interest cover the full month’s interest for the month in which you are closing. This interest would normally be included with your mortgage payment, however, since you will be skipping a mortgage payment when you refinance your lender will collect that month’s interest at closing.

#### Escrow:

If you are currently escrowing for taxes and insurance and you are refinancing with a different bank or lender than you have now, then the escrow account that you have with the old bank will be refunded to you within 2-3 weeks or them receiving the payoff money for the old mortgage. Upon closing a refinance, however, you will normally have to “front” money to establish a new escrow account for taxes and insurance at closing and be reimbursed by your old lender 2-3 weeks later. These funds are not considered out of pocket since you should be left whole in the end. With this in mind however, it is advisable to call your old bank and make sure that your old escrow account is not currently short funds and therefore not left with any surprises at closing.

## Should I wrap in my closing costs?

Depending on the equity in your property, you may be able to wrap in your closing costs to your new loan by increasing the loan amount. This is fine, but always remember that you are still paying the money one way or the other to close. Continue to go about your calculations the way you normally would if you paid them out of pocket. One popular option is to simply wrap the out-of-pocket closing costs into the loan and cover the interest and escrows at closing with the understanding that you are skipping a mortgage payment and getting an escrow reimbursement check from your old lender post-closing.

## What’s my overall savings?

This simple question may seem complicated but it’s not, as long as you eliminate your variables and solve for one item…overall interest on the loan.

The first thing that we want to do when calculating for this is to compare the total loan interest paid out on the new mortgage vs. the old given the same payments. Start by calculating the overall interest remaining on your current loan. An easy way to do this is to simply multiply the principal and interest payment without escrows by total payments remaining in the loan and then subtract the current principal balance. For example, if you have a mortgage balance of $370,000.00 and a monthly principal and interest payment is $1910.00 and you have 26 years (312 payments) remaining on your loan the calculation would look like this:

*1910.00 x 312 = $595,920.00 less $370,000.00 = $225,920.00 remaining interest on the loan.*

Unless you are shortening your term when you refinance, your payment will be going down if the rate is going down. To compare properly, you will want to assume that you continue to pay your mortgage at your current level. (The rationale for this is that if you don’t refinance, your mortgage payment will stay the same so the proper comparison to eliminate variables is to compare overall interest by refinancing and keeping the payment the same).

In the previous example if your mortgage rate was 4% and you were considering lowering it to 3.5% then you would need to take the 3.5% rate with a $1910.00 payment and see how long it would take to pay off that mortgage. In this case, the answer is 23 years and 10 months. Therefore, you are saving 26 months of $1910.00 payments or $49,660.00. Since we are not adjusting the payment we know that this represents the entirety of interest savings over the term of the loan.

How much your individual savings will be is determined by how long you are going to be in the home. The longer you are there, the closer the interest savings will be to the overall 24 year savings of $49,660.00. A simplistic way to calculate this is to say your annual savings will approximate the overall savings divided by the number of years to pay off for the new mortgage. In this example, it would be approximately $49,660.00 / 24 or approximately $$2,069.00 per year. Therefore if you were there 10 years your overall savings would be approximately just over $20,000.00.

The only remaining item to figure out is how long will it take to make up closing costs. If we conclude that out-of-pocket closing costs will be $4000.00 then how long will it take for the interest savings to equate to $4000.00? A simple way to approximate this is to take the overall loan amount x the difference in interest rate as your annualized interest savings. In our example this would equate to $370,000.00 x .5% = $1,850.00 per year. As you can see, it will take just over 2 years to make up the closing costs with the interest savings.

One question that always plagues homeowners who are looking to refinance after rates have dropped is “Should I wait to see if rates come down further”. The general rule to this is that you want to lock in your savings as rates drop. This may mean refinancing multiple times in a one- or two-year period. In our current example, deciding to wait could cost you somewhere between $20,000 and $50,000.00 if you guess the market incorrectly. If you would not normally take this money to Las Vegas to play roulette, then don’t try to outguess the market. Lock in your savings every time you can, even if it means paying closing costs each time to do it. You’ll be much better off in the long run.

Using these tools, we hope that you will be able to make a more informed decision about when is a good time for you to consider a refinance.