Rates are low. Again. Should you refinance your mortgage?

But what about the sacred "rules of thumb." Aren’t you supposed to wait until rates get at least 2 percent below your current rate? Or wait two years? Or perhaps you’re supposed to recover your closing costs in two years?

There sure seem to be a lot of “rules of thumb” when it comes to refinancing! Guess what? Forget the rules.

Refinancing a mortgage is simply that, replacing your current mortgage with another one for the purposes of lower payments, a shorter term or combining two loans into one. Whichever reason you’re using to refinance, pay less attention to any “rules of thumb” and pay more attention if refinancing is really worth your while.

How?

Take the lower monthly payment and divide the difference into the closing costs needed to close your new transaction. The result is the number of months required to “recover” the closing costs paid. For instance, if your monthly savings are $150 per month and your closing costs add up to $1,650 then it would take 11 months to recoup your costs. That’s about it.

Would you need to wait two years to make it worthwhile to refinance? Of course not. In fact, if you waited until rates dropped another ½ percent to get to the magic “two years” date you may wait for two more things: lost Interest savings because you didn’t refinance sooner and the possibility that rates will turn back up!

On the flip side, if you refinanced and saved $150.00 per month but immediately got transferred and had to sell your home, the fact is that you would never recover those closing costs, much less enjoy lower payments on that house.

So if the question is whether or not to refinance, the answer really is this: it makes sense to refinance if you will have the new mortgage long enough to recover your closing costs.

How long is reasonable? Your mileage may vary, as they say, but anything less then 4 years may be appropriate.

You may also want to consider a no fee refinance in lieu of paying closing costs. Your lender will, happily, offer a higher interest rate in lieu of your paying closing costs. Instead of paying $2,000.00 in closing fees such as appraisal, title insurance or origination fees, your lender might offer a rate which is somewhat higher than current market levels but lower than your current rate.

Many times, such loans make a lot of sense. To see if it makes sense for you, take the difference in monthly payments and divide that amount into your closing costs. You might find out that your monthly payment will be a little higher on a no-fee loan, but the difference is marginal compared to the amount of closing costs associated with the lower rate.

Note, there is no such thing as a “No Closing Cost” or "Zero Closing Cost" loan. In fact, some states even disallow use of such terms by lenders, and with good reason: There are closing costs! Instead of paying them at closing, they're buried in your new, higher rate. You pay every month.

Some borrowers may also find that refinancing to a shorter term makes more sense that a lower payment. On a $100,000 mortgage with an 8.5% 30 year-fixed rate, the payment is $751.00 per month. Over the life of that loan, you’d pay $170,455 in interest. Let’s say today you could get a 15 year fixed refinance rate at 6.25%. The monthly payment would be just over $857.00 every month. But over the life of the loan, you could potentially save over $122,000 in interest alone! So even though the monthly payment goes up instead of down, the interest savings alone would prod most homeowners to consider refinancing the term.

Should you wait to refinance even though your current mortgage is still a little wet behind the ears? There may in fact be no clear-cut answer. But if your situation shows that you can save money without paying substantial long-term interest, you can forget all the so-called “rules of thumb”.

Call up a few lenders. Refinance ‘till the cows come home.

Published: January 25, 2001

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, a veteran Mortgage Banker, successful Real Estate Consultant and author of Your Guide to VA Loans, Mortgages 101: Quick Answers to Over 250 Critical Questions About Your Home Loan, Who Says You Can't Buy a Home!, and Mortgage Confidential: What You Need to Know That Your Lender Won't Tell You, is a former columnist and Contributing Editor with San Diego-based Mortgage Originator Magazine. Reed is President of CD Reed Mortgage Bankers, Austin, TX and is a Past President of the Austin Mortgage Bankers Association.