When should you refinance your mortgage?

Refinance rates are still near historic lows. Here’s how to determine whether you will benefit by refinancing your mortgage.

Types of refinances

■ Rate-and-term refinancing to save money. Typically, you refinance your remaining balance for a lower interest rate and a term you can afford. The term is the number of years it will take to repay the loan.

■ Cash-out refinancing, in which you take out a new mortgage for more than you owed. You take the difference in cash or you use it to pay off existing debt.

Other reasons people refinance are to replace an adjustable-rate mortgage with a fixed-rate loan, to settle a divorce or to eliminate Federal Housing Administration mortgage insurance.

Breaking even

Mortgage closing costs can total thousands of dollars.

To decide whether a refinance makes sense, calculate the break-even point, the time it will take for the mortgage refinance to pay for itself.

Break-even point equals total closing costs divided by monthly savings. Example: 30 months to break even equals $3,000 in closing costs divided by $100 a month in savings.

If you plan to keep the house for less than the break-even time, you probably should stay in your current mortgage.

Mind the term

The formula above doesn’t measure your total savings over the life of the new mortgage. A refinance can cost more money in the long run if you start your new loan with a 30-year term.

Example: Kris has been paying $998 a month for 10 years. If Kris doesn’t refinance, the payments will total $239,520 over the next 20 years.

After refinancing, Kris could pay $697 a month to repay the new loan in 30 years, or $885 a month to pay it off in 20 years.

■ $697 times 360 months equals $250,920.

■ $885 times 240 months equals $212,400.

In the example above, Kris borrowed $186,000 at 5 percent. Ten years later, Kris had a remaining balance of $146,000, and refinanced at 4 percent.

Cash-out refinances

Cash-out refinances often are used to pay down debt. They have pros and cons.

Imagine that you use a cash-out refinance to pay off credit card debt. On the pro side, you’re reducing the interest rate on the credit card debt.

On the con side, you may pay thousands more in interest because you’re taking up to 30 years to pay off the balance you transferred from your credit card to your mortgage.

But the biggest risk in this scenario is in converting an unsecured debt into a secured debt. Miss your credit card payments, and you get nasty calls from debt collectors and a lower credit score.

Miss mortgage payments, and you can lose your home to foreclosure. Home equity debt that is added to the refinanced mortgage always was secured debt.