WHY REFINANCE?

There are a number of reasons to consider refinancing the loan on your home. Some people refinance as a way of taking advantage of lower interest rates, enabling them to reduce their monthly mortgage payments. Some refinance to a shorter-term mortgage, which enables them to build equity in their homes faster. And some homeowners refinance to tap into the equity they've accumulated in their houses, using the funds for home improvement or other needs, such as debt consolidation or their children's education.

The refinancing process is very simple. It involves paying off your existing mortgage loan and taking out a new one on the same house. Your new mortgage loan could be at a more attractive interest rate, or for a different term. Or, you could get an entirely different type of loan — for example, you could switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage.

When considering whether to refinance, there are certain rules that you must follow to reach the goal desired. Straying from some of these basics can end up not only costing time, but could end up costing more money in the future.

The 2% Rule of Thumb?
The traditional refinance rule of thumb that you must get an interest rate at least 2% below the interest rate you currently have – is often wrong. Waiting for a two percent difference from your rate to show up in the marketplace can actually cost you money. For some people, as little as one-half of one percent can be enough, if all other factors fall into place. The only way to determine whether refinancing is for you is to go about it the right way: by analyzing the time and the cost factors.

What Is Your Time Frame?
Simply put, it's how long you plan on holding this mortgage, although it can be more complicated than that. You might have a product that demands refinancing – like a balloon mortgage – your time frame is only until the balloon period runs out. But, if you don't have to refinance, your time frame can be as long as you plan to stay in the home you're in. When determining your time factor, it's crucial to be honest with yourself, since the time factor will determine if and when you begin to save money. Evaluating all possibilities is vital, but only you know what your time frame will be.

More or Less Mortgage?
One other factor involved in refinancing your mortgage: how much money you'll need or want to borrow. Most lenders will let you borrow around 80% of your home's current appraised value. Some will allow more, if you're simply refinancing your existing loan. But, if you're looking to tap equity, known in the mortgage industry as a 'cash-out refi', you'll probably find that it's less than 80%. In many cases, cashing-out will mean that you'll have a larger mortgage balance than before, with possibly a higher monthly payment – and you'll have to qualify for that new mortgage.

Cash-out Refi or Home Equity Loan?
If freeing up cash in your home is what you'd like to do, there's a way to do so, even without refinancing: taking a home-equity loan. Home equity loans can be a viable alternative to a cash-out refi, although they are not without their own set of risks. Most Home Equity loans are of the adjustable-rate, revolving 'line of credit' type, and work much like a credit card does, and lenders will generally offer you as much as 75% of the equity in your home (the appraised value less the balance of your first mortgage). Most lines are pegged to the Prime rate plus a margin, but be careful – most don't have per-adjustment interest rate caps, and some have lifetime caps of as much as 25%. There are fixed rate home equity loans available too, and they function much like any first or second mortgage does, but will cost you more than a line of credit.