What to Look At Before You Refinance a Mortgage

By Richard Barrington
NFNS Columnist

Understandably, mortgage holders get excited when interest rates fall. Adjustable rate mortgage holders can look forward to the possibility of their interest rates resetting to lower levels, while fixed rate mortgage holders figure they can refinance to the lower rates. Even so, there are a couple of factors besides interest rates that you need to weigh before deciding to refinance. Specifically, it is important to factor in refinance penalties (also called prepayment penalties) and closing costs.

Refinance or Prepayment Penalties

Refinance penalties are charges you may be assessed if you pay off your mortgage early. Not all mortgages have refinance penalties, so check your mortgage terms to see if this applies to you. You wouldn't want to refinance at a lower interest rate, only to find the advantage of doing so wiped out by a refinance penalty.

Why do mortgage companies sometimes charge refinance penalties?  First of all, it costs money to originate or acquire a mortgage. Second, if it is an adjustable rate mortgage, the mortgage company may have offered a low initial teaser rate. In either case, the mortgage company might legitimately anticipate recouping these costs by earning interest over the life of the mortgage. If the mortgage is paid off early, they need to be compensated for losing this opportunity.

Note that when you refinance, check not only your existing mortgage but also your potential new mortgage for refinance charges. After all, you may want to refinance again in the future.

Closing Costs

Closing costs a normal part of initiating any mortgage, including a refinance. You may want to use a mortgage calculator to compare the closing costs against the interest you will be saving, to see how long it would take you to recoup those closing costs.

Because of closing costs, you won't want to refinance with every incremental drop in interest rates. Wait for drops that are significant enough to represent meaningful savings, even after accounting for refinance penalties and closing costs.

About the Author:
Richard Barrington is a freelance writer and novelist who previously spent over twenty years as an investment industry executive.

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