You've heard it before: Now seems like a great time to refinance your home. If you're about to skip this paragraph because the rates available aren't two percentage points below your existing rate or because you've recently refinanced, wait! Experts say the 2 percent rule isn't necessarily the best benchmark. In the past, a 2 percent reduction was necessary to cover refinancing costs. In some cases, the lender also charged "points," with each point amounting to 1 percent of the loan amount. But as interest rates have fallen, policies have changed. Today, because of high levels of consumer debt and increasing competition from home equity lenders, banks and mortgage brokers are offering homeowners better deals.
To get the best deal, be skeptical of offers that tout no out-of-pocket costs. Fees are often included in the total amount borrowed, meaning you pay those fees, plus interest, over the life of the loan. It may be more prudent to pay points upfront. "Points should be considered if you're going to live in your home for more than five years because by the sixth year, you'll recoup the upfront fee you'll pay in points through savings on the monthly payments," says Suzanne Bach of IPI Financial Services in New York City.
Say the amount you want to borrow is $250,000, and you can get a 30-year mortgage at a 7 percent rate with no points. Your monthly payment is $1,663. With one point, the rate drops to 6.75 percent for a monthly payment of $1,621. The difference in payments is $42 per month. If you're paying $2,500 extra for the one point upfront, how long will it take to recoup? Divide the cost of the point by the difference between the loan amounts. The answer is the number of months it will take to make up the cost of the point. In this case, it'd be about 60 months. If you're considering paying more than one point to get an even lower rate, Bach notes it will still take about five years to make up the difference, but after the 60th month, your savings will be $42 per month. Plus, in most cases, points paid at closing are tax-deductible. Consult your tax advisor.