Rules for Refinancing a Home

General Rules to Determine If Refinancing is Worth It

When you refinance your home, you cancel your previous mortgage and open a new one, preferably at a much lower interest rate. As with your previous mortgage, there are a number of closing costs. Generally, the rule of thumb on refinancing is that if you don't intend to live in your home for at least three years, it isn't worth it. In addition, some advisers don't recommend refinancing unless the new interest rate is at least 2 percent lower than your current one or you have at least 5 percent to 10 percent equity. Use online calculators to determine how much you expect to save at the new interest rate once you've deducted the closing costs. Generally, if you can expect to recoup the costs within 12 to 16 months, it's probably worth it to refinance.

Review your current mortgage to determine if you will incur any prepayment penalty fees. You could incur thousands by refinancing too early. Depending on the size of your prepayment penalty, it may be best to wait it out before refinancing. Other costs include the application fees, title search and title insurance fees, the lender's attorney's review fees, loan origination fees and appraisal fees. Expect the fees to account for 3 percent to 6 percent of the total loan. If your current mortgage is fairly new or you are refinancing with the same lender, you may be able to waive title fees, by asking about reissue rates. An existing lender may also waive appraisal fees and credit-report fees.

No-cost or no-fee refinancing boasts minimal or no upfront fees. In reality, the costs are distributed over the life of the loan, in the form of a slightly higher interest rate. Unless you intend to pay your mortgage off within a few years, avoid no-cost refinancing. It's also best to pay your upfront costs at closing, to avoid paying interest on those costs. Also, opt for a shorter mortgage to further reduce the amount of interest you will pay.

As a homeowner, you must pay property taxes and insurance on your home. Failure to pay your property taxes could result in having a lien put on your home. To avoid this, the mortgage company may require you to put the money toward these expenses in an escrow account, so it can pay your taxes when due. If you are someone who struggles to stay on top of bills or to remember when payments are due, this could make life that much more convenient. Plus, having an escrow account may result in a lower interest rate. However, when your money is in an escrow account, the lender collects any interest earned on that money. Had you held the money, you would have collected the interest. By choosing not to escrow, you may reduce your upfront costs. Do the math to determine which approach is right for you.