Sorry I’ve been incommunicado for a few months. But now I’m back, and I’ll try to post a couple times a month, at least until we get closer to tax season.

First off, when you’re thinking about refinancing your mortgage, you might not immediately think about your taxes, but consider — you get to deduct your mortgage interest from your taxes. How much of a role should that play in your refinancing decision? I suggest trying to calculate it. It might be that you’ll save more by refinancing than by not — but you’ll never know until you see the actual numbers.

With interest rates falling, homeowners not able to sell their homes and falling victim to foreclosure, everyone’s thinking about refinancing their mortgages.

So what is refinancing and why do people refinance their current mortgages?

To refinance is to re-negotiate the terms of your mortgage. It’s a do-over. Whether or not to refinance is dependent on the homeowner’s personal and/or financial situation. And, the reasons given for refinancing are varied. Some of the most common reasons are:

• The interest rates on your current mortgage are significantly higher than what the market is offering. By refinancing, you can get a better rate, which will in turn lower your monthly mortgage payment. Refinancing also extends the length of your loan (unless you choose to shorten it by getting a 15-year loan or something), which also helps to lower your payment. Whether you should let interest rates guide you depends on the terms of both your current and prospective loans and how long you intend to keep the property before selling it. If you plan to stay in the house a while, it might be wise to refinance. If you’re planning to sell soon, then you need to calculate how much money you’ll save each month, and how long it will take you to save back the money you have to put out to refinance — namely, the closing costs. If you’re going to sell before you would have saved back the money, then don’t do the refinance.
• You want to shorten or lengthen the term of the mortgage. The most common term for a mortgage is 30 years. However, there are also mortgages for 15, 25, 30, 40 and 50 years. By refinancing, you can reduce the length of your mortgage to the time limit you think you can afford to make timely mortgage payment, e.g., from 30 years to 15 years. This way you also reduce the amount of interest you would have paid if the mortgage went to its full term of 30 years. Shortening is a great idea for people looking to retire in less than 30 years, because it’s a good idea to have the house paid off before you retire. On the other hand, if you’re in your 20’s or 30’s and have time on your side, but your mortgage payments are killing you, then you might want to refinance to extend your mortgage, which would lower your payments (and quite possibly save your credit rating).
• You decide you want to take equity out of your home. Depending on your down payment, after paying your mortgage for at least five years, you start to build up equity in your home. Equity is the difference between the appraised value — or what your home can be sold for — and the amount you currently owe on your home. In recent years, many people have been refinancing to take money out so they could pay off credit cards and other debt. Whether this is a good idea or not is iffy. Yes, there’s a tax break on the mortgage interest. But remember, your goal is to pay off your house by the time you retire. If you keep taking money out, you’ll never get it paid off. Then you’ll be stuck working long after you should’ve have been able to retire. Think about that for a while before refinancing to get some quick cash.
• Get out from under a risky type of mortgage. If you got caught up in the mortgage frenzy in recent years (before the bubble burst), you might have an ARM (adjustable rate mortgage), or worse, an interest-only loan. Refinancing to convert from your ARM to a fixed rate mortgage can be a very good idea, particularly if you plan to stay in the house for a long time. In fact, do it now, while the interest rates are relatively low. Chances are good that your ARM has already adjusted to an interest rate higher than what you could refinance to.
• You want to improve your credit ratings. One final main reason homeowners refinance is to achieve a better future credit score rating. If you have derogatory credit information on your credit report - delinquencies, bankruptcy, late payments, judgments and/or liens on your property - the credit reporting bureaus will give you poor credit scores. Refinancing might be the only option you have to pay off your debts, clean up your credit ratings and start your life all over. If that’s the case, then refinance now…as long as you’re going to stay in the house long enough to cover the closing costs (see above). In fact, go for the lowest possible payment while still opting for safety — choose a fixed loan with the longest period you can get: 30-years, or if possible, 40- or 50-years. And if you have the money, consider paying some extra points in order to get your interest rate (and payment) even lower. But again, include the cost of the extra points when you calculate how long it’ll take to get the closing costs back.

Notice that refinancing to take more money out so you can take a bigger tax deduction isn’t on the list. Keep that in mind as you’re making your decision. There are other ways to get a bigger tax deduction, and if refinancing isn’t a good idea for you for other reasons, then don’t do it.

Best of luck with your refinancing!

This entry was posted on Friday, October 12th, 2007 at 10:13 am and is filed under Tax Deduction. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.