Most people consider refinancing their home mortgage to take advantage of lower interest rates and reduce their monthly mortgage payment. Refinancing a mortgage means paying off your old mortgage and signing a contract for a new loan. Whether to refinance your mortgage is a difficult question to answer, and should be based on the following considerations:
A general guideline is to consider refinancing a mortgage when the current mortgage interest rates are at least two or more percentage points below what you are paying now.
The following chart shows what you would pay by refinancing your mortgage at certain interest rates. Assume you started out with a 10 percent, 30-year fixed-rate mortgage for $120,000 with $1,053.09 monthly payment.
|Present 30-Year Mortgage Rate||Monthly Payment ($)||Monthly Difference ($)||Yearly Difference ($)||Total Interest Paid after 30 Years|
|Source: computer using the mortgage calculator at bloomberg.com|
A lower mortgage interest rate means you pay less total interest per year, and thus, there is less interest available to deduct from your income for tax purposes. Your income-tax liability is likely to increase, and the savings in mortgage interest must offset this. The total impact of a reduced mortgage interest rate depends on factors such as your income, tax bracket, and other deductions. (See the Refinancing Your Mortgage Work Sheet at the end of this publication.)
Some refinancing costs may be tax deductible in the year you refinance. However, discount points usually must be deducted over the life of the mortgage, even if paid upfront. Check with your local IRS office.
Each discount point is equal to 1 percent of the loan amount. Charging points is a method lenders use to adjust interest rates, so the lower the interest rate, the more points you may have to pay. The higher the interest rate, the fewer points. Points and interest rates figured together determine the annual percentage rate (APR). Lenders are required by law to provide you with the APR, and it is a good way to compare combinations of points and interest rates to determine the best deal. But remember, there are other costs, such as closing costs, associated with refinancing that must also be considered.
|USUAL CLOSING COSTS||AVERAGE CHARGES|
|Loan origination fee||usually 1% of the loan amount|
|Discount points||0-1.5% of loan amount|
|Title insurance for lender||$3.50/$1000 of loan|
|The above average charges are according to Clay Greenway, Mortgage Capital Investors Loan Officer|
If the value of your home has increased, you may want to look at the possibility of refinancing more than the value of your current mortgage. Since mortgage interest remains a deductible expense on federal income taxes, there are guidelines on how the equity can be used to take advantage of the full interest deduction. If the amount of the new mortgage is equal to or below the original price you paid for the house, the full interest deduction will apply. You can also use the equity for home improvements or other allowable expenses such as education or medical expenses or to cover closing costs of the refinance. Again, consult your local IRS office because there are limitations on how much of the total costs are allowable.
Appraisals are required to determine the value of the home and the loan amount. In some cases, homeowners who look at refinancing find that their homes have increased or decreased in value over time. If the value has decreased, refinancing may not be an option since most lenders will only refinance 80 percent of the home's current value, and the amount of the original mortgage may exceed this amount. If a lender does refinance more than 80 percent of the home's current value, the lender will require mortgage insurance, which will increase the closing costs and the monthly mortgage payment.
It is important to remember that your home is at risk if you default, no matter what expenses were paid for with the equity.
Another option you might consider is to refinance your mortgage for a shorter time period. Although your mortgage payments will be somewhat higher, you will pay less interest over the life of the loan, and build equity more quickly.
Federal Trade Commission Headquarters
Washington, DC 20580
Mortgage Bankers Association of America
1125 Fifteenth Street, N.W.
Washington, DC 20005
Original Authors: Patricia Gorman, graduate assistant, and Kathleen Parrott, professor of housing and former Extension housing specialist, Department of Apparel, Housing, and Resource Management, Virginia Tech
Virginia Cooperative Extension materials are available for public use, reprint, or citation without further permission, provided the use includes credit to the author and to Virginia Cooperative Extension, Virginia Tech, and Virginia State University.
Issued in furtherance of Cooperative Extension work, Virginia Polytechnic Institute and State University, Virginia State University, and the U.S. Department of Agriculture cooperating. Edwin J. Jones, Director, Virginia Cooperative Extension, Virginia Tech, Blacksburg; M. Ray McKinnie, Administrator, 1890 Extension Program, Virginia State University, Petersburg.
May 1, 2009