The Motley Fool

How To: Make The Most From Refinancing

For most homeowners, mortgage payments dwarf all other living expenses. When an opportunity comes to reduce those payments, many jump at it. Some homeowners, however, jump a little too quickly.

Focusing solely on how much you can save from refinancing is tempting. After all, depending on your mortgage, a small decrease in increase rates can yield significant savings (perhaps even enough for a monthly meal at a nice restaurant?) Yet, some people argue that this decision-making process for whether to refinance is too simplistic, and that waiting for bigger savings is better for most borrowers in the long run.

Turning down free money
When one consider the benefits of refinancing, we often compare the reduction in monthly payments against the cost of refinancing.  Financial planners do that too.  When the amount saved exceeds the costs by more than a tiny amount, the planners will often recommend that homeowners replace their current mortgage.

It’s hard to argue against saving money.  After all, who doesn’t want to save money.  But by focusing on how much you can save, some people actually save less than they could by refinancing too early.

Weighing the costs
The analysis hinges on the fact that refinancing costs money. If you could refinance for free, you could grab a few extra dollars every time interest rates experienced a small dip. But when you consider mortgage application fees, title insurance premiums, and other costs, you can’t afford to refinance every day.

Therefore, you should think carefully about when you should refinance your home loan. For instance, if you could save $25 a month now, deciding to refinance may mean giving up the possibility of saving $50 or $100 a month if rates continue to fall.

Analyzing a number of factors, including the size of your mortgage, the length of time you’ll stay in your home, and the volatility of interest rates, research has shown that the optimal time to refinance for those who intend to stay in their homes indefinitely is when rates have fallen 1%-2% from your existing mortgage.  For those planning to move in the near future, rates may have to fall even further before it makes sense to refinance.

Look before you leap
This analysis of refinancing options serves as a reminder that many financial decisions are more complicated than they seem at first. It’s smart to look for savings anywhere you can. But by jumping at the first opportunity to save small amounts, you could give up the chance to reap bigger savings later.