Rethinking refinancing: with mortgage rates on the rise, does it still make sense to refinance?

Thirty-year fixed mortgage rates reached a 30-year low this past June when they dipped below 5%. It's no wonder most homeowners had high expectations as they hurried to refinance their existing loans, hoping to put some extra cash in their pockets. Even though rates have since climbed back, hovering around 6.25%, they're still better than two years ago when rates were more than 7%.

Most experts agree that interest rate reduction is the main reason behind most refinancing decisions. Even small variations in interest rates can make a critical difference. Greg McBride, a senior financial analyst at BankRate.com, a leading consumer banking marketplace on the Internet, says that insisting on a 2% or 3% rate drop before refinancing is an old rule of thumb that no longer applies. He adds that a one-quarter to three-quarter percent rate drop is worth considering "as long as the homeowner intends to stay in the home long enough to recoup the expenses."

Sandra Evans knows firsthand the savings that a good refinancing deal can produce. The 42-year-old, single mother of two owns a single-family home in Mount Vernon, New York. Initially, she purchased the dwelling as investment property in September 2002, with a 7.87% rate on a 30-year mortgage. In July 2003, Evans, an executive assistant to the president of a venture capital firm in Roseland, New Jersey, decided to refinance the home as a residential property. She says she wanted to take advantage of the low interest rate environment. This second time around, she was able to get a rate of 5.25% on a 30-year mortgage. By shaving more than two percentage points, Evans realized monthly savings of nearly $400 on her $236,000 home. Her monthly mortgage payment, including taxes and insurance, is now $1,713. She has since moved into the home with her mother, brother, and her children.

Evans was a perfect candidate for refinancing. With a huge interest rate drop on a house she doesn't plan to sell anytime soon, the benefits and the timing of her refinancing could not have been better, says Marc Giles, a mortgage specialist and CEO of Overnight Funding, the Bronx, New York-based mortgage brokering firm that handled Evans' transaction. She applied online at OvernightFunding.com.

But refinancing may not always be the best move for every homeowner. Apart from lower interest rates, an important consideration should be the cost of refinancing, including closing costs, the mortgage size, and the length of the loan, cautions Carl Morgan, currently the small business relationship manager at an HSBC bank in New York City, formerly a loan officer in the mortgage department at Chase Manhattan Bank. For instance, someone who is 10 years into a 30 year mortgage may not want to refinance into a new 30 year-mortgage, leaving them 40 years to pay off the home loan.

What if your credit is worse now than when you first purchased your home? If you have made late payments on your mortgage, credit cards, or auto loans since you bought your home, your credit score will have fallen, says Morgan. You may not even qualify for the best rates, he adds. Refinancing in this case could actually boost your payments and interest bill rather than lower them.

On the other hand, Giles says there are those who want to refinance and take cash out at the closing to pay off higher interest rate credit cards or other debts (at 6% vs. 17%), or those who wish to convert their mortgages from 30-year fixed terms to 15-year terms in order to build equity more quickly and slash their total interest bill. Also, homeowners who pay for private mortgage insurance (PMI) because they made a down payment of less than 20% could refinance to get rid of mortgage insurance if they have built up equity in their homes. In all those instances, refinancing makes perfect sense, says Giles.