Decision to refinance mortgage can be based on numerous factors

Sure, you could refinance your mortgage. But should you?

The answer depends primarily on your personal circumstances, including the interest rate and terms of your current mortgage, and how long you expect to continue to own your home.

But beyond those and other individual issues, there are also some broader considerations that might help you figure out whether to refinance or stand pat.

Rates drop, applications rise

There's no question that mortgage rates have fallen since the beginning of the year, causing mortgage refinancing to build momentum quickly. In the week that ended Jan. 18 the Mortgage Bankers Association's index of applications to refinance existing mortgage jumped almost 17 percent compared with the prior week, and the share of refinance activity as a percentage of total loan applications increased to 66 percent, a week-over-week rise of 4 percent. Both the volume of applications and the share of applications that were to refinance had increased in the prior week-to-week comparisons as well.

Unlike prior refinancing booms, however, the current flurry of activity isn't just about low interest rates. Many borrowers want to replace an adjustable-rate mortgage with a less risky fixed-rate product, according to Doug Duncan, chief economist of the MBA, who noted this trend in a Jan. 24 podcast posted on the association's Web site.

Possible reasons to refinance:

-- Get a lower interest rate.

-- Replace an ARM with fixed-rate loan.

-- Consolidate loans to one monthly payment.

"We have seen a dramatic pickup in refinance activity for those households who have good credit and are in markets with stable house prices, many of them shifting from adjustable-rate mortgages to fixed-rate mortgages and stabilizing that sector of the homeowner population," Duncan says.

Lower interest rate, less risk are good reasons to refinance

Obtaining a lower interest rate or replacing an ARM with a fixed-rate loan are perhaps the two most compelling reasons to refinance, says Steve Stein, senior vice president of WaMu's Home Loans Group.

"We are certainly seeing more customers who can refinance into a better rate even for the same kind of product ... (and) for customers who have some kind of an ARM product, this is a great time to move to a product that has less fluctuation in the interest rate over a period of time," Stein says.

Another reason to refinance might be to replace multiple loans, such as a first mortgage and a home equity loan or a home equity line of credit, with just one loan and one monthly payment.

The current downward direction of interest rates might result in lower payments on an existing line of credit without the trouble of refinancing, but fixing the payments on a first and a second mortgage by refinancing into a new first still "may make some sense" for some borrowers, Stein says.

Longer term can erase

benefit of lower rate

Regardless of your motivation, you should consider the costs and the term of your new loan before you decide to go ahead, Stein says. While the out-of-pocket costs may be modest, they're typically not zero, and other costs may be added to your loan balance to be paid off as part of your total loan amount.

One way to measure the materiality of those costs is to calculate a payback period by dividing the monthly mortgage-payment savings into the total cost of refinancing. For example, if your new loan reduced your payments by $50 per month and the total cost to refinance was $2,400, the payback period would be 48 months, or four years. Note that this calculation doesn't take into account the fact that you could apply that $2,400 to other financial opportunities if you didn't refinance or that you would have to make more payments if you extended the term of your loan.

Poor reasons for refinancing:

-- The cost is more than the payback period.

-- Cashing out home equity in return for a higher rate.

-- Gambling with the perpetual "lower-rate game."

The day when you'll eventually pay off your loan in full may seem like a very long time away, but it's still worth having an "end game" in mind, Stein says. For instance, if you've already paid off seven or eight years of your mortgage, you might want to refinance into a loan with a 15-, 20- or 25-year term instead of a new 30-year term because the additional interest you'd owe over those extra years of payments might negate the benefit of a lower interest rate.

"It makes sense to continue to reduce the term as you refinance so you don't simply go back to a longer amortization term for the purpose of getting a lower payment. That may suit some people, but in general people want to be thinking about what their long-term financial objectives are," Stein said.

The decision to cash out home equity for other purposes is also more difficult today since values generally haven't appreciated at the same rapid pace that was common a few years ago. Borrowers should "get some smart advice" before they pull equity out of their property, Stein says. It's not smart to refinance your mortgage at a higher interest rate just to get extra equity.

Should you try to 'time'

the mortgage market?

A perpetual quest to capture the lowest possible interest rate is another poor reason to refinance, says Ben Borden, owner of Virginia Mortgage Bankers in Richmond, Va.

"A lot of people get caught up in the lower rate game, and it's a battle for them. Every time rates drop, they try to go and get the lowest rate, and that's a bad reason" to refinance, he says. "There will always be a rate that's lower. It's kind of pointless."

A more vexing question may be whether to refinance now or wait to see whether interest rates will fall further. Borden believes borrowers would be better off to wait since the current interest-rate trend has been downward.