It May Be Time to Refinance, If You Play It Smart

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This is a revised version, updated Jan. 22, of an article initially published on Jan. 14.

Mortgage refinancing is rising in popularity again -- and in light of today's emergency 0.75 percentage-point interest-rate cut by the Federal Reserve, it may look like an even better move.

With the refinance share of mortgage activity last week increasing to 62.7% of total applications from 57.7% the previous week, as the Mortgage Bankers Association announced Wednesday, it's clear that a lot of people have already jumped on board.

The average contract interest rate for 30-year fixed-rate mortgages decreased in the week ending Jan. 11 to 5.62% from 5.73%, while the 15-year fixed-rate mortgages decreased to 5.07% from 5.21%, says the MBA.

"Given the current trends in the housing market and the economy in general, it would not be surprising to see mortgage rates moving lower through out 2008," says Steve Habetz, president of Threshold Mortgage in Westport, Conn.

He suggests that if one needs to refinance, now is a good time to do so: "Rates tend to move down slowly and up with a vengeance."

"While there's a chance rates could drop further, there is more room for them to go up," agrees Sue Baxter, a senior loan officer with IndyMac Bank in Stamford, Conn. For those considering a refinance, "waiting for a 0.125% rate change or better is a gamble," she says. "Some banks offer a float-down option which may enable a borrower to take advantage of a rate drop."

There are a couple other factors homeowners may want to keep in mind when considering a refinance.

Consider the Costs

Although the interest rate on the refinance might be lower than your current loan, taking out any loan will still cost you money. For example, you should factor in closing costs to determine how long it might take you to break even on the change, say experts. Also, the tax deductibility of the refinance might differ from your existing loan.

"Most homeowners know that the points they pay to obtain a mortgage are tax deductible. When you refinance, however, any points you pay must be amortized over the life of the loan. In other words, you can't take the full deduction for the points in one year, as you can do when you buy a house," says Lynnette Khalfani-Cox, The Money Coach and author of Your First Home: The Smart Way to Get It and Keep It.

"Even if you hear lenders talk about a so-called 'no cost' refinancing, don't believe it," she says. "A lender might not have an application fee, or charge you points to refinance, but those costs and others associated with refinancing are essentially priced into a loan with a higher interest rate. A refinancing entails paying off your old loan and replacing it with a new one, and banks aren't in the business of making loans free of charge."

Don't Get Greedy

In the third quarter of 2007, 87% of loans owned by Freddie Mac(FRE) that were refinanced resulted in new mortgages with loan amounts that were at least 5% higher than the original mortgage balances, according to Freddie Mac's quarterly refinance review. The revised share for the second quarter of 2007 was 84%.

Loan experts at Livonia, Mich.-based Quicken Loans find that about half of its clients take cash out when they refinance, says Bob Walters, the chief economist for the online retail mortgage lender. ""We haven't done any formal survey," he says, "but I would say anecdotally that the top reasons people extract equity are to pay down credit card bills and make major repairs or improvements to their homes."

In 2006 alone, Americans cashed out $352 billion worth of home equity -- more than a tenfold increase in the amount cashed in 2000. Personal-finance experts say that is not always a wise decision.

"You should never refinance into a larger loan than is necessary," says Khalfani-Cox. "Unfortunately, scores of homeowners do this all the time when they sign on the dotted line for a cash-out refinance, which allows you to not only get a better rate or more favorable loan terms, but which also allows you to get some dollars back in the deal as well. A cash-out refinancing saps equity from your home, so you should only take that money if you plan to use the proceeds wisely."

The Joint Center for Housing Studies at Harvard's "State of the Nation's Housing 2007" annual survey found that 13% of recent homebuyers already have negative equity in their homes, meaning their outstanding mortgage debt exceeds the market value of the houses in question. Similar results came from Zillow.com in November. The online real estate service found that nearly 16% of homebuyers who purchased houses in 2006 had negative equity, as did 17.5% of those who bought in 2005.

The rise in home prices over the past decade has led some homeowners to tap into their equity, but now with prices declining drastically in some areas, people should pay close attention to what is happening in their local markets before they decide to take cash out, say experts.

"If prices are falling, [homeowners] may find that by waiting for a lower rate they either no longer have sufficient equity in their home to obtain a refinance or that they will have to incur the additional cost of mortgage insurance in order to obtain a new loan," says Habetz. "Many states have mandated a net-tangible benefit standard for homeowners looking to refinance. Consumers should be weighing their options now and determining what the net tangible benefit is of refinancing -- whether their legislature requires it or not."

Here's another take on whether refinancing is right for you.

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