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When Refinancing a Mortgage, Be Aware of All the Costs

However, if you really want to save money by refinancing your mortgage, you need to consider the costs of refinancing: origination costs involved in taking out a new mortgage, insurance premiums, and any loss in tax savings, among other expenses.

What is known as the break-even period is the time it will take to offset the refinancing costs.  If someone is planning to have the new mortgage for longer than the break-even period, then he or she will end up saving money.

There are "no-cost" mortgages, but they usually carry a higher rate, and may not be a good deal.

Borrowers who have a fixed-rate mortgage benefit from refinancing only if the new interest rate is significantly lower. "If you have a good fixed rate, of 6.5% or less, you don't need to refinance," says Carolyn Warren, mortgage consultant and author of Mortgage Rip-offs and Money Savers.

"We're not in a big refinance rush," she adds. "People who bought houses five years ago, and who had good credit, are not refinancing so much. There would have to be a big drop in rates."

On the other hand, people with an adjustable mortgage should consider it. "If your rate is going to be adjusting soon, I would refinance now," says Warren. "The speculation is that rates could be a quarter percent higher at the end of the year. There's no reason to wait."

Those who are struggling to make payments, or who live in declining markets (in which case lenders will require more equity in a house), should seek loans backed by the Federal Housing Authority (FHA), says Warren.  "Right now they're not looking at declining markets. It's a break that they're giving to borrowers," she explains.

An FHA loan, which is insured by the government, is more flexible in its requirements in terms of credit scores. The program also helps homeowners who can no longer afford their mortgages and missed up to three monthly payments over the past year. Lenders who refinance with FHA backing sometimes write down the outstanding subprime principal balances.

People who need to make home improvements, or consolidate credit card debt, may choose a cash-out refinance loan. In this case, the new mortgage is for a higher amount than what is owed on a house.

Let's say someone owes $150,000 and is paying an interest of 8%. This person can replace this loan with one for $200,000, pocketing the extra $50,000. With cash-out refinancing, interest rates might be higher than regular refinancing, says Warren, and there may be tighter credit score requirements.

If you can, avoid cash-out loans. "Don't use your house like an ATM machine," says Warren. "Even if you're not in your ideal home, it's still in your best interest to preserve the cash you're going need to get your dream house later."

This article was written in June 2008

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