A Better Deal:Refinancing Your Mortgage

Question of the week:I want to refinance my mortgage before rates go up again, but there are a few different kinds of mortgages and I'm not sure which one is best. Any advice? --Ben G.

Dear Ben,

With mortgage interest rates at lows that haven't been seen in two generations, you've got plenty of company in your rush to refinance. When we asked members of the Armchair Millionaire community about how much money they're saving by refinancing, we could almost hear the glee. Here are a couple of examples:

"Just refinanced the house with a similar payment as in the past but we will save ten years of payments and tons of interest!" --de losangeles

"I refinanced two months ago, taking me from a 4-year adjustable to a 6.25% 30-year fixed with no points or pre-payment penalty. This saves me $140 per month after the cost of the refinance is recouped." --Kevin

There are several different reasons to refinance, and you should know exactly what you want to get from the refinance in order to choose your best loan option. These are main reasons people are refinancing:

• To reduce monthly payments. By lowering your interest rate, not only will your payment drop, you'll also build up equity a bit faster.
• To shorten the term. Many people are switching from a 30-year to a 15-year loan. Your monthly payment will go up, but you'll pay much less interest overall and be mortgage-free much sooner.
• To tap into equity. "Cash-out" refinances allow you to pay off the old mortgage, plus obtain cash. They're used by many people to pay for home improvement, college or other major expenses.
• To switch from an adjustable-rate to a fixed-rate. If you took out an adjustable rate mortgage when interest rates were higher, you might want to switch now to the predictability of a fixed-rate loan.

Once you decide which option is right for you, make sure you get the best deal. My quick guide tells you the key things you should know.

The Armchair Millionaire Guide to Refinancing Your Mortgage

• Know the terms. In a fixed-rate mortgage, the interest rate will not change-and your payments will remain constant-for the life of the loan, typically 30 or 15 years. They're a good idea when interest rates are low, or whenever you want the security of knowing exactly what your payments will be. In an adjustable-rate mortgage (ARM), the interest rate starts out lower than comparable fixed-rate loans, but is adjusted (either up or down) periodically as market interest rates change. ARMs are enticing when interest rates are high and people figure that rates are only likely to go down in the future.

• Know the APR. Lenders are required to tell you the APR (short for "annual percentage rate") to make it easier for you to compare two different loans. While the interest rate tells you only interest charged on the loan amount, the APR also takes into account many of the costs of the loan, such as points, lender fees and mortgage insurance. I regard the APR as a much more realistic number than the interest rate.

• Know the points. A point is simply a fee that is one percent of the loan amount. It can get confusing, however, because there are actually two kinds of points. Discount points are a fee you pay up -front in order to lower the interest rate of your loan. Origination points are a fee charged by the lender to help cover their costs. Avoid origination points if at all possible; consider discount points if they make sense for your situation.

• Know the costs. Some costs are unavoidable, such as title search and insurance, appraisal and recording fees. However, there are a slew of other fees that many lenders will try to charge, all of which go to their bottom lines. They can include "underwriting fees," "mortgage broker fees," "processing fees," and "application fees." Lenders are required to let you know these costs upfront as part of their Good Faith Estimate, so if they seem unreasonable, either negotiate them down or take your business elsewhere.

THE BOTTOM LINE: Refinancing can be expensive and time-consuming, so make sure you know what you want out of a loan before you start the process.