The Basics of Refinancing Your Mortgage

Can you save more money and avoid debt by changing your mortgage rates? Find out what's right for you.

You would think that mortgage applications always come from people looking to buy a house. But you would be wrong.

Currently, about two-thirds of the mortgage applications in the United States are from customers who already have homes and just want to change the terms of their mortgages. In other words, they're looking to refinance their mortgages. (Learn about mortgage modification through Obama's Making Home Affordable program; see Resources, below.)

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Big Savings

A refinance can change the basic terms of a mortgage -- for example, it can convert a 30-year fixed loan to a 15-year fixed one. Most refinances, however, are attempts by consumers to save money as interest rates fall (see Resources, below).

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For example, if you bought a house two years ago and got a 6 percent interest rate on your loan, it might be worth refinancing now to take advantage of current rates, which are closer to 5 percent. That means you're being charged less for your mortgage, which can translate to less money paid to the bank.

Frank Nothaft, vice president and chief economist of Freddie Mac, notes that the typical borrower who refinanced during the first quarter of this year got a 1.2 percentage point reduction in interest rates. (That would result in a savings of about $300 per month for someone carrying a $400,000 mortgage.)

What's more, because the housing market is in a slowdown, banks aren't issuing that many new mortgages, so they're trying to encourage refinancing. As a result, many banks will let you roll closing costs and fees into your loan balance, so you can pay them off slowly as part of your mortgage instead of paying upfront.

But if you're more than a few years away from paying off your loan, it might not make sense to refinance. That's because even though your interest rate may drop, your loan term might become 30 years again. So if you bought a home in 2006 with a 30-year mortgage, if you do nothing but make the payments, you'll have it paid off in 2036. If you refinance, the time when you become debt-free might be pushed off five years, to 2041.

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