Is it worth it to refinance your mortgage? With recent signs that interest rates may be headed back down again, many people may be wondering if refinancing would make sense for them. As always, the devil is in the details.

Unfortunately, there are no easy answers. Although the basic question is simple enough - will you save enough on your monthly payments to make up the closing costs of the refinance? - answering that question can get fairly complicated. Fortunately, there are some fairly straightforward rules of thumb to help you cut through the clutter and get a good sense of whether a refinance might merit further investigation.

The first question is, how much can you save by refinancing your mortgage at a lower interest rate? Let's say you bought your house several years ago and are paying 6.25 percent on a $250,000 30-year fixed rate mortgage. Your monthly mortgage payment (not including escrows for property taxes and insurance) would be about $1540. That same 30-year mortgage at today's posted rate of 5.24 percent would be about $1380- a savings of $160 a month. Sounds like a pretty sweet deal, right?

Will refinance savings exceed closing costs?

The next thing you need to consider is how much it will cost you to refinance the mortgage in terms of closing costs. Refinancing means getting a whole new mortgage - so you're going to have closing costs, just like when you first bought the house. These are generally about 2-3 percent of the loan amount, although they may range as high as 5 percent if you have shaky credit or don't shop around for your loan. rLikewise, those with good credit who compare lenders can end up paying less.

Let's assume your closing costs are 2 percent on a $250,000 mortgage - that works out to $5,000 in closing costs. That may seem like a lot, but if you're saving $160 a month, you'll get that back in just over 2.5 years - a pretty good deal. Even if your closing costs are 3 percent, or $7,500, you'll get it back in under four years - still not bad, particularly if you plan on staying in the home for a long time.

Here's where things start to get a bit complicated. If you've been in your house for several years, you've already been paying down your principal. If, in the example above, you'd been making payments for five years on a $250,000 mortgage at 6.25 percent, you'd be down to about $230,000 in principal with 25 years to go on the loan.

Stretching out the term of the loan

But the lender isn't likely to want to give you a 25-year loan at 5.24. They're going to want to put you in a new 30-year loan at that rate. The good news here is that your monthly payments will be even lower, since you're stretching the payments out further. On the downside, your total savings over the life of the loan will be reduced, because you'll be making interest payments for another five years.

Stretching out the term of the loan can be an attractive option for those who need to reduce their monthly mortgage payments - you're not only getting a lower rate, you're getting more time to pay off the loan. However, because of compounding interest, you could actually end up paying more over the life of the loan, a situation that becomes more likely 1) the longer you've been paying on your current mortgage and 2) the smaller the difference between your old and new interest rates.

In general, people with larger mortgages can benefit from smaller reductions in the interest rate, because closing costs do not increase proportionately with the size of the loan - closing costs are likely to be a smaller percentage on a $400,000 loan than they are on a $100,000 one.

Subprime borrowers may want to take another look

Another class of people who may benefit from refinancing are those who had weak credit and got into a subprime loan when they took out their original mortgage. If they've stayed current on their payments since then, they may not realize how much their credit has improved, meaning they can qualify for the better rates now available. For them, it may be worthwhile to order a copy of their credit report to see what their standing is - if it's risen above 700, they may be able to get a very good rate.

What it comes down to is, you're going to have to do your homework and you're going to have to shop around. The determining factors are going to be your actual closing costs, the reduction in your monthly mortgage payment and the compounded interest you pay over the life of the refinanced loan at your new rate. Once you get a handle on those, you'll have a much better idea of whether a refinance might work for you.

Published on June 29, 2009