Mortgage rates have dropped again, and we are now back in the all time low range we were at earlier this year. If you didn’t refinance your mortgage earlier this year, it might be time to look at it again and see if lowering your mortgage rate and payment would help you now. A few years back refinancing your mortgage was an automatic any time that mortgage rates dropped. It is more complicated now because mortgage guidelines have gotten tighter, making it harder for some to qualify, and with home prices down it isn’t a slam dunk that your home will appraise out to the value needed. But there are programs which make it easier to refinance even if you don’t have a lot of equity (or none) in your home.

The FHA Sreamline Refinance – This is available only if you already have an FHA mortgage. This (up until it changes in November 2009) is the easiest and most inexpensive mortgage around. If you can lower your rate an payment you can refinance without a new appraisal or credit qualifying, and roll most of your costs into the new loan.

FHA refinance – With this program you will still need to show that you qualify and we will need to order a new appraisal, but for a refinance where you aren’t taking any cash out, you can refinance up to 96.5% of the home’s value.

Fannie Mae and Freddie Mac Home Affordable (Obama Refinance) – These programs are ways to lower your rate even if your home value has gone down. Most lenders will now accept up to 100% of your current value, and mortgage insurance will be based on what it was when you originally took on the loan.

Refinancing can make a lot of sense if you are lowering your rate and payment without incurring a lot of up-front costs. The more you pay up-front to close the loan, the longer it will take for the lower mortgage payments to pay off the higher cost of getting the loan. This can still make sense if you are sure that you will be in the home for a long time, and you want to lock in the lowest rates. But too often the lowest rate isn’t the best value. If you are thinking of refinancing your mortgage, you should always do a break even or pay back calculation. For this you need to know 3 things:

1. How much will you save by refinancing?
2. How much will it cost to refinance?
3. How long do you think you will stay in the home, and with this mortgage?

To find out how long it will take for you to break even, figure out how much your loan will cost you (the bank fees and title charges on your Good Faith Estimate) and divide this by the amount you will save on a monthly basis (the difference between your new mortgage payment and your current payment). This will give you the amount of months that it will take to pay off the closing costs and break even on your new loan. For example, if it costs you $1,600 (this is what I am currently quoting for bank fees and title charges for a no point loan in the Chicago area) and you are saving $50 per month, it will take you 32 months to break even, and every month after that you will be saving money.

On the other hand, if the loan cost more to close, you should be saving a lot more each month. For another example, let’s say you are paying a point (1% of the loan amount) and the cost of the new loan is now $4,600. If your new payment is now $100 better than what you are currently paying, it will take 46 months ($4,600 divided by 100) before you break even. So even though the rate on the second option is lower, and the monthly savings are higher, the first option is going to be better for the near term. You then need to decide how long you think you will be in the loan, and if it makes sense to pay the extra to get the long term benefit. In many cases it will, but in most cases it takes about five years to pay off any up front points. You need to see which option makes the most sense for your own situation. You can also go the other way. Instead of paying points or closing costs, for many borrowers the best option is a no cost refinance. With this program the lender increases the rate slightly and uses the yield spread premium (what we are paid to make the loan) to pay all the closing costs.

I’ve heard all sorts of rules of thumb of when it makes sense to refinance, but each situation is different. It would take a big rate reduction to make sense to refinance a small loan, but with a larger loan a small reduction in rate could pay off quickly. Run the numbers yourself (or give me a call and I can walk you through the options) and you will make the decision that works best for you.

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