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Q: With interest rates so low right now, am I missing a good bet if I don’t refinance my 30-year mortgage, which carries an 8.5 percent rate?

A: Many factors—including how many years into your first mortgage you are, how good your credit rating is (this determines how low a rate you will qualify for), and what the closing costs and prepayment penalties will be—should be considered before you refinance. That said, with mortgage rates at 40-year lows (the average rate currently is 6.15 percent), most people—even those who refinanced within the past few years—have an incentive to refinance now.

            The power of mortgage financing can’t be underestimated. Refi’s provide an immediate and permanent boost to household cash flow, regardless of whether cash is taken out of the transaction. (With cash-out refinancing, you refinance your mortgage for more than you currently owe, and receive the difference in cash.)  Even when the equity of the home is tapped and cash is removed, total household debt does not rise, because consumers tend to use the extra cash to pay down their credit-card debt or other loans, which carry a higher interest rate and are not tax-deductible. When consumers substitute tax-deductible mortgage debt for other forms of debt, their financing costs fall and they benefit on a recurring, monthly basis.

            Even in a straight refinance, with no cash-out, you come out ahead, because, by lowering the interest rate you are paying, you reduce your monthly payments for the term of the new loan, which frees up household income to be spent on all your other wants and needs. And this benefit lasts for the term of the loan, usually 30 years. Notice that households receive this benefit whether or not they choose to increase the size of their mortgage, which would tap the equity accrued in their homes.

            Another way consumers can take advantage of the current low interest rates is to shorten the length of their mortgage terms. In your case, because you would be paying less in interest after you refinance, you could afford to pay more toward the principal each month, and pay off your mortgage in 15 or 20 years instead of 30. You may end up paying the same amount or a little more per month than you did at the higher rate, but you’ll increase your equity more rapidly and save tens of thousands of dollars in interest. 

            Interest rates on home-equity loans are also very attractive right now. In fact, some banks are offering lower short-term home-equity rates than refinance rates, according to www.bankrate.com, which is unusual. Another advantage of home-equity loans is that they carry no closing costs. And you are only charged interest on the amount you borrow. When deciding whether to refinance or tap into your equity, always do the math: calculating all present and future costs, how long it will take you to pay off your debt, what the interest charges will amount to over time—and how much you will save over your current mortgage costs.

            When consumers tap the equity in their homes, they get a one-time gain. But if home values continue to rise over time, as most everyone believes will continue to occur over the long term, such households will be able to do so again sometime in the future. Some people warn that the current housing bubble could collapse, and the value of these homes could fall, leaving these families with little or no equity in their homes. But even if that does occur, it would likely be temporary and housing prices would move higher when the market recovers.

            History shows that what comes down, eventually climbs back up. Interest rates are bound to rise again, as the economy improves.  But the lower monthly mortgage payments will endure for those who are smart enough to take advantage of low rates now. So, if you haven’t refinanced your mortgage yet, don’t wait too long to make your move.  

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Dr. Charles Lieberman, an investment strategist, who oversees the  "Portfolio Partners" investment program of Advisors Financial Center, LLC (AFC), provided the answer to this question. You may contact him by phone at 845-368-0938, or e-mail him at chuckl@portfoliopartners.com. 

To research current mortgage interest rates, estimate your savings, and find out more about the pros and cons of refinancing and home-equity loans, visit www.bankrate.com.

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