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What you should ask before you refinance your mortgage

Ask the Expert
Lelsey-Becker-Refinance-Adobe-Illo
. —Lesley Becker/Globe staff; Adobe Stock

This time last year, there was one thing most real estate economists could agree on: Mortgage rates would keep drifting upward. Economists at the Mortgage Bankers Association and Freddie Mac predicted that rates on a 30-year mortgage would hover at 5.1 percent in 2019, while Realtor.com’s chief economist thought rates might touch 5.5 percent by the end of this year. Zillow predicted rates would hit 5.8 percent, “territory not seen since the dark days of 2008.’’

Instead, mortgage rates seemed to hop on an L.L.Bean toboggan last December and coast merrily downhill to a three-year low in September. That fueled a flurry of refinancing and the best quarter for mortgage lenders in more than a decade.

“We’re seeing a massive uptick in refinance activity this year that we did not plan on,’’ said Shant Bonosian, branch manager at Guaranteed Rate in Waltham. “We’ve refinanced more people already this year than we have in the last three years combined.’’

On Nov. 29, 2018, the average rate on a 30-year fixed-rate mortgage was 4.81 percent, according to Freddie Mac. That’s hardly high by historical standards. But as of mid-November, the average rate on a 30-year mortgage had fallen more than a full percentage point, to 3.75 percent — offering recent home buyers a chance to lock in even lower interest payments. “Anybody who bought a house last year should be evaluating their mortgage right now,’’ Bonosian said.

For example, if you took out a $350,000 mortgage a year ago at 4.85 percent and refinanced it now at 3.85 percent, you’d lower your mortgage payment by about $230 a month and save roughly $60,000 in interest over the life of the loan. That makes refinancing sound like a double no-brainer — and it very often is. But such calculations rely on key assumptions, such as how long you’re going to stay in the home.

“Just because your new mortgage costs you less each month doesn’t mean you are actually saving money in either the short term or long haul,’’ said Keith Gumbinger, vice president at the mortgage website HSH.com. “If it costs you $3,000 out of pocket to refinance, and your cash flow is improved by $100 per month, you don’t start to get actual savings until 30 months have passed,’’ he said. That means that if you sell the home before the break-even point, you will have cost yourself money.

So before you jump to refinance, here are a few things to consider.

What is your goal?

There are a number of reasons you may want to refinance your mortgage. So make sure the new loan, including all of its fees and terms, helps you achieve your goal.

Usually, if rates have dropped (or your credit score has improved) since you took out your loan, you can save money by securing a lower monthly payment and reducing the interest you’ll owe — sometimes by tens of thousands of dollars. “Pay attention to the fees and total interest over the time you will have the loan, not just the rate,’’ said Jennifer Lane, a certified financial planner with Compass Planning Associates in Wellesley. If you expect to stay in your home for the long haul, Lane suggests running an amortization schedule on your current mortgage to see how much interest you’re slated to shell out between now and the payoff date. “Compare that to the total interest and refinance costs that you’ll pay with the new mortgage.’’

Some people refinance to consolidate their mortgage and a second loan or home equity line of credit. Others use what’s called a “cash-out’’ refinance to access home equity, basically taking out a bigger mortgage and pocketing the difference to pay for a remodeling project or other expense. If you opt for a cash-out refinance, make sure it closes before you begin construction, cautioned Kevin Kuechler, senior loan officer at Draper & Kramer Mortgage Corp. in Franklin. “It can be very difficult to secure traditional, low-cost financing when a home is in the middle of a project with open permits,’’ Kuechler said.

Borrowers who purchased their home with an adjustable-rate mortgage may want to refinance to lock in a long-term fixed rate that’s low. Still other homeowners take advantage of lower rates to shave years off their mortgage without adding a whole lot to their monthly payment — refinancing down to a 15-year loan, for example. “The shorter term coupled with the lower rate makes their long-term goal of being mortgage-free by retirement an easier reality,’’ said Gary Moukhtarian, senior vice president of consumer finances at Webster Bank in Waterbury, Conn.

And while it’s not generally recommended, you can extend your loan term to free up cash flow. For instance, refinancing into a new 30-year mortgage when you’re already three years into the original loan will probably lower your monthly payment, even if the rate isn’t much better, simply by stretching out the loan. But this ignores the long haul, Gumbinger said. “You have to consider that you will now have paid for your home not for 30 years, but for 33 years,’’ he said. “While cash-flow improvement can certainly have value, it’s not necessarily savings.’’

It costs money to save money

The reason refinancing isn’t always a slam-dunk is that taking out a new mortgage is expensive. Moukhtarian said closing costs on a refinance loan will be comparable to what you paid the first time around or slightly less. While fees such as title insurance will vary because they’re tied to the loan amount, lender and legal fees average roughly $3,500 to $4,000, he said, not including prepaid charges like insurance.

Gumbinger says the best way to estimate closing costs for your specific property is to pull out your existing loan’s “closing disclosure’’ form or, for older loans, your HUD-1 settlement statement. “These detail each of the fees the borrower paid to get the existing loan, and a refinance will be very similar,’’ he said, except for fees that don’t need to be repeated. “For example, you won’t need to buy a new homeowner’s insurance policy, as you already have one in force. Also, you may be able to get a ‘reissue rate’ for your title insurance, so that would lower some costs, too.’’

If you’re happy with your current lender, start there. They might be able to offer you a lower-cost, less-hassle, “streamlined’’ refinance because they have your information on file. “This might mean simply updating certain existing paperwork and signing new documents,’’ Gumbinger said. Federal Housing Administration loans can qualify for a streamlined refinance process as well.

What’s your time frame?

You can generally pay closing costs upfront or choose to wrap them into the loan. And just like first mortgages, you can purchase “points’’ (equivalent to 1 percent of the loan amount) to buy down the interest rate. If you’ve realized that you’re in your forever home — or, at least, your 30-year home — paying more to lock in a lower rate will generally be money well spent. However, the more your loan costs in fees and points, the longer you’ll have to stay put to break even. If you plan to sell next year and you pay $5,000 to refinance into a 30-year loan, Moukhtarian said, “whether you pay out of pocket or roll it into the loan, you’re not going to recoup that investment.’’

Some lenders offer “no-cost’’ refinancing, which basically just trades those fees for a higher interest rate. The monthly and long-term savings won’t be as dramatic, but it might be the best option if you don’t know how long you’ll stay in your home. “You would start saving immediately,’’ Gumbinger said.

Want to pay off your mortgage early?

As mentioned, refinancing into a shorter-term loan can help you pay off your mortgage years ahead of schedule. Alternatively, you can take whatever savings the refinance yields and use some or all of it to make an additional payment toward your principal each month. “These are rough numbers, but an extra $100 applied to the principal each month will reduce the term of the mortgage from 30 to 27.9 years, approximately, and it saves roughly $28,000 in interest over the life of the loan,’’ Moukhtarian said.

Meanwhile, if you’re more than a decade deep into your mortgage, you may want to be careful, because refinancing restarts the clock on your amortization schedule — that complex table that breaks down how much of each payment goes toward interest and how much is applied to your balance. “The sooner you refinance from when you took out the last loan, the better, because you’re not as deep into the amortization of your loan,’’ Bonosian said.

Here’s what that means: Lenders like to get their money upfront, so in the early years of a mortgage term, you’re mostly just paying interest. In fact, it’s usually 10 to 16 years into a 30-year loan before at least half of your monthly payment goes toward your principal balance, allowing you to make real progress and build equity faster. If you refinance at that point, even into a 15-year mortgage, you’ll be right back to paying mostly interest for the next few years. “The bank wins in a refinance because the payments are reset back to the beginning of the amortization schedule,’’ Lane said.

Lane recently ran the numbers for a client who was looking to refinance into a shorter, 15-year mortgage, to pay if off sooner. “It turned out to make more sense to increase the amount they pay to principal on the old mortgage to get it paid off quicker than it did to refinance to a shorter term,’’ she said, even at a lower interest rate.

Don’t go chasing rates

Gumbinger said it’s a mistake to try to time the bottom of the market and obsess over getting the lowest rate. As last year’s expert predictions make clear, no one knows whether rates will rise or fall.

“Mortgage rates are notoriously fickle and can be highly volatile from day to day and week to week,’’ Gumbinger said. “Better you should know the rate that makes your refinance make sense for your situation, and when it becomes available, grab it.’’

Jon Gorey blogs about homes at HouseandHammer.com. Send comments to jongorey@gmail.com. Follow him on Twitter at @jongorey. Subscribe to our free real estate newsletter at pages.email.bostonglobe.com/AddressSignUp.