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Refinance a Low Rate - Should You or Shouldn't You?

Many people with perfectly good interest rates refinance their home mortgage when it actually might not be in their best interest to do so. They are persuaded to refinance by their mortgage broker or loan officer, or perhaps they have heard so much about low mortgage rates in the media that they feel compelled to refinance when, in fact, their current loan is just fine and maybe all they need to do is pay a little extra principal every once in a while.

There are, however, many other people with low rates (even in the 5.5% to 6.5% range) who have circumstances where a refinance could benefit them if done properly (and for the right reasons).   

Top 10 Reasons to Refinance a Low Mortgage Rate

Here are the top ten reasons to consider a refinance even if you currently have a low mortgage rate.  Some of them are obvious and some are not

Obvious:

  1. You are in an adjustable rate loan that is either at a high rate now or has the potential to go higher.
  2. You have a second mortgage or home equity line with a high rate and large enough balance that if refinanced into a new first mortgage would save you money.
  3. You want to use your home equity to make improvements to your house that will increase its value or “livability.”
  4. You need to “buy out” the equity of a spouse or co-owner.
  5. You have credit card debt that just doesn’t seem to go away and you need it to. This could be a very good or a very bad idea and should only be considered if you have the discipline to leave the credit cards alone after paying them off.  The last thing you want to do is to use your home equity to pay off debt and then max out your cards again.

Not so obvious:

  1. You want to use your home equity for the down payment or purchase of a second home or investment property. (Given the recent decline in home values this is a great time to do it).
  2. You can’t seem to come up with the money you need to start saving for retirement or for a child’s college fund.  A refinance with cash out can get you the funds you need to get things going in a big way.
  3. You recently inherited a home and you would like to use the equity to buy another home, invest for retirement, a child’s education, renovate the property, etc.
  4. You took out a 15 year loan a while back, but in your current financial situation you need the lower payments of a 30 year fixed rate.
  5. You can’t seem to bring yourself to pay ANY additional principal at all, you have debts to consolidate and you would like to pay your loan off quicker - this is when you want to consider a 20 year fixed.

All of the above require that you have a decent chunk of equity, so if you have the equity you owe it to yourself to take a good hard look at your financial goals to see if it makes sense to consider a “cash out” refinance in spite of the fact that you have a low rate.  (And now is the time since the current rates are not going to be around forever).

“The 3% Solution” - a solution for those who do not need to refinance

Many people are unaware of what is referred to as the “3% solution.”  Essentially, it is a means of paying off a 30 year loan in about 17 years by paying an extra 3% towards your mortgage payment. 

Basically, you just add an additional 3% of your (principal and interest) payment to your mortgage payment and mark it as “additional principal.”  For example, if your payment is $1500 then you pay $1500 plus an additional $45 (3%) for a total of $1545 for the first 12 months, then you add another 3% ($46.35) to the $1545 for a total of $1591.35 in the second year and so on.  You keep adding 3% to the payment each year until you have it paid off.  Obviously, your mortgage payment becomes 3% more expensive each year, but most people can handle it since they tend to make 3 to 5% more each year than the year before.  Of course, if you have other debt that has a higher rate than your mortgage then you want to apply a similar (but more aggressive) strategy to that debt. 

It might seem illogical to refinance out of a great rate, but if you take a closer look at the possibilities you might find yourself in a better financial position down the road.

John King of MyMortgageBanker.com takes a consultative approach to mortgage lending and educates his clients about all possible mortgage options.