Your Money > Your Home
Are you a refi junkie?
Refinancing is all the rage. But when does this savvy financial move become a short-sighted mistake?
May 27, 2003: 4:53 PM EDT
By Sarah Max, CNN/Money Staff Writer

New York (CNN/Money) - This summer you won't have to listen to your neighbor bragging about his latest undiscovered tech stock. Instead, he might spend the better part of your annual barbecue telling you about his latest coup de finance -- refinancing his mortgage.

With mortgage rates still near new lows, homeowners are lining up to refinance. Demand for mortgages still is zooming, according to the Mortgage Bankers Association of America, with refinancings accounting for three-fourths of all applications.

Much of that is coming from repeat customers.

"This low rate cycle has been going on for three years now," said Doug Perry, first vice president of Countrywide Home Loans. "It's not uncommon to see people who've refinanced two or three times over this cycle."

Indeed, the old rule of refinancing only after rates drop two percentage points is about as passť as paying cash. These days, homeowners are willing to go through the hassle of refinancing to trim their rates by a percentage point or less.

Can you blame them? The 30-year mortgage rate is below 5.5 percent, down from 6.81 percent this time last year.

Bringing a 30-year loan for $400,000 from a 5.75 percent rate to a 5.25 rate saves more than $120 a month in mortgage payments and more than $45,000 in interest over the life of the loan.

But there are times when squeezing every bit of interest out of your loan makes sense and times when it does not.

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"I have one client, we'll call Cindy, who has refinanced eight times in four or five years, and that doesn't include the times I've done a second mortgage for her," said Bill Roberts, owner of The Mortgage Specialists in Redmond, Ore.

Roberts adds that Cindy refinanced to consolidate debt, only to turn around and spend more. "It got to the point where her husband asked if I could do something to help her, so I steered her toward a mortgage with a pre-payment penalty."

There's a fine line between being a savvy homeowner and a "refi junkie." How do you know when it's gone too far?

You're oblivious to upfront costs

Before you go about refinancing, you'll want to have a good estimate of the upfront costs. A typical transaction will cost 1 percent of your loan plus title insurance, attorney fees, origination fees, appraisal fees and the cost of running a credit report.

If you refinance through your current lender you may be able to save on some of these fees. Still, you can expect to pay anywhere from $2,000 to $4,000 for a $200,000 loan.

You can calculate your "break even point" by dividing your up-front costs by what you'll save each month in mortgage payments. If you'll save $100 a month, but pay $2,000 in up-front costs, it will take you 20 months to recover your costs. Such a deal makes sense if you plan to stay in the house for a while, but not if you think you'll be moving in a year.

Something else to keep in mind: The more you refinance, the higher your up-front costs are likely to be, and you may have no choice but to take a loan with a pre-payment penalty.

"You can bet there is a fee or rate premium for rolling refinancers," said Keith Gumbinger, vice president of HSH Associates. "There are costs associated with originating a loan that are typically amortized over a period of time, which is why lenders may require more up front if they think you'll turn around and refinance again."

You keep extending you terms

One thing homeowners sometimes overlook when they refinance is that their new monthly payment is low not just because they've locked in a lower interest rate but because they've extended the term of their loan.

For example, if you're 20 years into a 30-year loan and refinance from a 6.5 percent rate to a 5.5 percent rate, your monthly payments will go down about $350 a month. But, because you're turning back the clock and paying off this loan over 30 years instead of 20, you'll pay an extra $50,000 in interest -- even with the lower rate.

You may be better off shortening your term to, say, 15 years or at the very least asking your lender if you can refinance with the existing term of your loan.

"With rates as low as they are people can cut years off the mortgage for the same monthly payment," said Gumbinger.

You refinance to pay your Visa

According to Gumbinger, one of the most popular reasons for refinancing is to extend the life of a loan (and lower monthly payments) and cash out on equity to consolidate debt. "Basically these people are interested in improving their cash flow," he said.

While borrowing against your home often makes sense -- not only do you get a low rate but you can in most cases deduct your interest -- it should not be a license to spend more.

Unfortunately, for many people, that's exactly what it is.

"Within a two years, two-thirds of people who pull equity out of their home have the same amount of debt as they had before they consolidated," said Chris Viale, general manager of Cambridge Credit Counseling Corp., nonprofit debt management firm. "People think they're saving money but really they're just cashing out, spending it and not adding to the value of their home."  Top of page

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