Don't Overtap the Refi Well

Refinancing has become an obsession with some homeowners. Many refinance over and over merely to save a few bucks. This is a far cry from the old adage that said you should only refinance if you can lower your mortgage interest rate by 2 percent.

The 2 percent rule applies to few borrowers who are actually refinancing today. However, there are other valid reasons to refinance.Some homeowners refinance to consolidate debt. Let's say you have $50,000 in credit card debt on which you're paying 18 percent interest. The $200,000 home you bought years ago is now worth $350,000. If you refinance into a $200,000 mortgage, you can pay off the existing $150,000 mortgage and the $50,000 of credit card debt. Instead of paying 18 percent interest on the $50,000, you'll pay only 6 percent.But, don't let refinancing to pay off debt become a bad habit. One of the benefits of owning real estate is that it can be a form of enforced savings. With every monthly payment, you're paying back a portion of the amount you borrowed. Overtime, your equity position grows. This coupled with price appreciation can result in a tidy nest egg.

If you tap into your equity periodically to pay off outstanding debts, your equity position is diminished. This could become a serious problem if you have to sell during a housing slump and you can't sell for enough to pay back your mortgage.

Another good reason to refinance is to lower your monthly payment. If you're currently paying 7 percent or more, it probably makes sense to refinance. Suppose your current mortgage is at 7 percent. You can refinance into a 6-1/4 percent mortgage with no fees charged upfront. This will save you $147 per month and $1,764 annually.

Refinancing Tip: If you bought several years ago and you're paying Private Mortgage Insurance (PMI), you may be able to save even more by refinancing. PMI is insurance that borrowers pay on a 90 percent mortgage to protect the lender in case the borrower defaults on the loan. The premiums for PMI vary, but they can add the equivalent of an extra 1/4 to 1/2 percent to your interest rate.

Your home may have appreciated sufficiently so that your remaining mortgage balance is equal to 80 percent of the current property value. If so, you can refinance into a lower interest mortgage that doesn't require PMI.

Another valid reason to refinance is to switch from one mortgage product to another. You may have purchased several years ago using a 5-year fixed mortgage that converts to an adjustable. At the time you thought you'd be moving again within 5 years. Now, you may have decided to stay put. Refinancing into a 30-year fixed mortgage at today's record low rates would make sense.

Refinancing doesn't make sense for everyone. For instance, if you have a relatively low mortgage balance, and you've been paying the balance down for a while, the savings you'll realize through refinancing a loan in the 6.5 to 7 percent range will be minimal. Also, every time you refinance a 30-year mortgage, you start the 30-year payoff over again from the beginning. A 5-year old loan has only 25 years to go.

It might make sense in this situation to refinance from a 30-year fixed loan into a 15-year loan. The monthly payments will be higher, but the interest rate lower. And, the overall interest paid during the course of the loan will be much less.

The Closing: If you're refinancing now and you're planning to refinance again if rates drop lower, choose a no-fee mortgage product.