This question was posed to me recently through
Quora, the question and answer web site. I did not answer it there
because an adequate answer in the short space that Quora likes was
impossible. But it made me think about why that was the case, and the
result was this article.
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“Should I retire?”
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“Should I trade-in my car?”
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“Should I marry Charles?”
Contingent questions are unanswerable without more information
provided by the questioner. The interesting thing is that in my 3 other
examples, the contingent nature of the question would generally be
recognized, so that anyone posing any of these questions would include
information that the questioner felt was relevant. But “Should I
refinance?” was asked with no additional information provided. This
probably reflects a lack of understanding that mortgage refinances have
a variety of purposes, and that the success of a refinance depends on a
range of factors that vary with the purpose. This article is designed as
a guide.
Purpose is Lower Interest Cost
Most borrowers contemplating the refinance of a fixed-rate mortgage
want to know whether the financial gain from a lower interest rate more
than offsets the refinance costs. This is less important as a motivation
than it was a year ago because of the rise in rates that has since
occurred. It remains relevant, however, to borrowers with older
higher-rate mortgages who for one reason or another failed to refinance
when rates were at their lowest.
I have 3 calculators on my web site directed to this question. They
all measure the benefits of a rate-reduction refinance relative to the
refinance costs.
Calculator 3a is for borrowers who have one mortgage that will be
refinanced into another mortgage.
Calculator 3b is for borrowers who have both a first and a second
mortgage that will be refinanced into one new mortgage.
Calculator 3c is for borrowers who have one mortgage
carrying private mortgage insurance and will be refinancing into a
combination first and second mortgage without mortgage insurance.
Purpose Is to Raise Cash
Another reason borrowers refinance is to raise cash. While cash-out
refinances are priced higher than rate-reduction refinances, this is not
in itself a deterrent to the borrower who needs cash. What matters to
that borrower is whether the cost of the cash-out refinance is larger or
smaller than the cost of raising the same amount of cash with a second
mortgage.
Calculator 3d on my site is directed to this question.
Purpose Is to Reduce the Risk of Higher Rates on an
ARM
Borrowers who now have an adjustable rate mortgage (ARM)
and are concerned about rising interest rates have their own
reason for considering a refinance. They want to know whether the likely
loss from retaining their ARM exceeds the cost of eliminating the risk
by refinancing into an FRM.
Calculator 3e is designed to answer their question.
Purpose Is to Make Rate-Reduction Refinance
Possible by Paying Down the Loan Balance
Some borrowers have mortgage interest rates above the current market
but they can’t refinance into a lower rate because their house value has
depreciated. They want to know whether paying down the balance on their
existing FRM in order to lower the cost of refinancing into another FRM
would yield a satisfactory rate of return. These are sometimes called
“cash-in refinances”. My
Calculator 3e is designed to answer that question.
Purpose Is to Eliminate High-Cost Short-Term Debt
by Consolidating it into One or Two Mortgages
Borrowers who are burdened with short-term debt may want to know
whether it pays to consolidate such debt in a cash-out refinance.
Calculator 3e is designed to answer their question. If the
borrower has only one mortgage, he can use my
Calculator 1b. It compares the cost of consolidating the short-term
debt in a new and larger first mortgage, or in a second mortgage.
Calculator 1c assumes the borrower has two mortgages plus
other debt, which can be consolidated with a cash-out refinance or a new
second mortgage.
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