Home Equity Loan - When Does Refinancing Make Sense?

For the last two years, interest rates have been much lower than anytime during the last thirty years. This has resulted in an unprecedented boom in real estate sales, home refinancing and home equity lending, as borrowers try to take advantage of these rates for the long term. But refinancing or even borrowing against your home’s equity may not make sense for everyone. When is it a good idea to refinance your home? When is it not advisable?

Traditionally, lenders advised homeowners not to refinance unless doing so would lower the interest rate on the loan by 1-2%. While anyone who can save 2% on their interest rate would almost certainly benefit from doing so, others might find refinancing worthwhile even with a smaller reduction in the interest rate. Increased competition among lenders has brought the costs of refinancing down in recent years, so homeowners can realize a significant reduction in their home payments with reductions of ½% or so, depending on the size of their mortgage.

The key to whether or not refinancing makes sense is how long the homeowner intends to remain in his or her home. The costs of the refinancing, which can run $1000-2000, are amortized over the life of the loan. For many people, a reduction of $50 or more in the house payment would be more than enough to justify a new mortgage. If payments cannot be reduced by at least that much, or if the homeowner plans to live in the home only a short while, refinancing may not be a good option.

Refinancing may also make sense for those with Adjustable Rate Mortgages (ARMs.) At the moment, at 30-year fixed-rate mortgage is quite competitive with an ARM, and may actually be cheaper. With rates at historic lows, an ARM can only adjust upward, making it a less desirable choice in comparison with a fixed-rate loan.

Anyone considering a home remodeling project or debt consolidation might ordinarily think of a home equity loan or line of credit. These are often wise choices, as they offer deductible interest and great repayment flexibility. On the other hand, a chance to obtain a 30-year loan at 5% might make a complete refinancing with a cash-out option a better choice, as home equity rates are somewhat higher than first mortgages.

A new mortgage might also make sense for anyone with a second mortgage or a piggyback loan. A piggyback loan is a second loan used at the time of a home’s purchase to help the buyer avoid paying the sometimes-expensive private mortgage insurance. Simultaneous payments on two mortgages will be higher than paying on one, so this might be a great time to roll them together on a refinance. The same applies to anyone carrying a large credit card balance; that money could be rolled into a home loan with deductible interest at a lower rate. Anyone considering such a move should be careful, however, as failure to repay that debt could lead to home foreclosure.

Now is a great time for any homeowner to consider whether or not a new mortgage could help lower their payments. With interest rates as low as they are now, the timing is great, and there’s nowhere for the rates to go but up.

by Charles Essmeier