Home equity versus conventional mortgage

Conventional wisdom maintained that it made sense to refinance your mortgage only if the rates dropped two percentage points. That advice has been replaced with new thinking. It may make sense to refinance even when the rate reduction is one point or less, as long as you plan to stay in your home long enough to recover the costs of refinancing.

While it's difficult to come up with one rule that covers with reasonable accuracy all the possible scenarios, the Society of Louisiana CPAs offers the following advice for people interested in learning more about the benefits of refinancing.

Why refinance?

"The most obvious reason for refinancing a mortgage loan is to obtain a lower rate of interest, which both reduces the interest expense required to carry the mortgage and your monthly payment," says LCPA President Thomas Cotton. "Today, people are attracted to refinancing for other reasons as well."

Refinancing also offers you a way to consolidate high-interest consumer debt. If your home has appreciated in value, you can refinance and draw on the equity in your home to pay off other debts. Mortgage rates that are half as high as credit card interest rates and the favorable tax treatment of home mortgage interest expense make refinancing a popular choice for debt-laden taxpayers. (Keep in mind that another tax-smart way to consolidate your debt is a home equity loan, where you can save on the closing costs.)

Some homeowners take advantage of lower interest rates by converting to a loan with a shorter term. This builds up equity in the home more quickly and can free up money for retirement or college tuition. Others refinance to trade in an adjustable rate mortgage (ARM) for the security of fixed monthly payments.

Finally, you may have taken out a mortgage several years ago that was considered a "jumbo mortgage" and paid a higher "nonconforming" mortgage rate. If that is the case, you may be able to refinance into a conforming loan because earlier this year Fannie Mae and Freddie Mac raised the limit on conforming loans to $275,000. If your "jumbo loan" is smaller than that, you may be eligible to refinance to a conforming, lower-rate loan.

Is it worth it?

Whether or not it makes sense for you to refinance depends, essentially, on how much money you'll save over the long term versus up-front costs for making the change. Some simple arithmetic can make that determination.

Begin by calculating how much you pay monthly with a new lower-rate mortgage. Subtract the new payment from your old payment to determine your monthly savings. Next, figure. the closing costs associated with, refinancing. Closing costs represent your out-of-pocket expenses to obtain that new mortgage. Fees for points, title searches, title insurance, appraisals and other charges vary from state to state and lender to lender. Any lender you are considering should be able to provide you with an estimate.

Finally, divide your total costs by monthly savings to determine how many months it will take to break even. For simplicity's sake, let's say the total cost of refinancing is $4,000 and your monthly interest on the new loan is $200 less. That means it will take you 20 months to break even (S4,000 divided by 200). If you plan on staying in the house longer than that, it probably is worth refinancing.

Shop around

The Internet has made it easier to search for and compare mortgage rates.. The Web site for HSH Associates (www.hsbassociates.com), the country's largest publisher, of mortgage data, is a comprehensive and objective source of information on mortgage rates.

When it comes to closing costs, while points typically are the major expense associated with refinancing, fees for title searches, title insurance, credit checks, attorney fees and related expenses all are likely to add up. Check with your current lender first. He or she may be willing to waive a few fees and requirements, especially if your first mortgage is only a couple of years old.

Consider taxes

CPAs recommend that you consider the tax implications of refinancing. The refinancing costs which result in lower rates, may also result in nondeductible charges. Paying less interest may change whether you can item ize deductions. Your individual circumstances and tax bracket determine how this affects you.

Courtesy of the Society of Louisiana Certified Public Accountants