If interest rates fall after a house has been purchased, many homeowners will be tempted to refinance. However, just because rates are 1 percent or 2 percent lower doesn't necessarily mean that it is wise to refinance immediately.

What is refinancing?
Refinancing a home mortgage involves paying off an existing home mortgage early by taking out a new mortgage at a lower interest rate.

The key statistic in deciding whether to refinance is learning how long it will take for you to “break even” with the refinancing costs as a result of reduced monthly payments based on the lower interest rate.

Generally, if it takes longer than three or at the most four years to recoup refinancing fees and closing costs, or if the new interest rate is 1 percent or less lower than your existing mortgage, it would not be profitable to refinance.

Should high interest mortgages always be refinanced?
Much depends on the terms of the original mortgage and the state of residence.

The primary governing variable is how much of a penalty will be assessed for paying off a mortgage before its maturity.

Some states, like New York, have laws stating that no prepayment penalty can be applied on fixed-rate mortgages after they have been in effect for one year or more.

Other states, like California, have no laws governing prepayment penalties. Thus, banks and mortgage companies can establish their own guidelines and charge whatever prepayment penalty they want to charge.

Because there are no national standards or guidelines governing prepayment penalties, the penalty assessed for refinancing can vary by thousands of dollars from state to state.

How to determine when to refinance
Before refinancing, homeowners need to do their homework and do some comparative shopping. There are four primary things that homeowners should do before deciding to refinance.

1. Shop for the best deal. Learn what your total closing costs will be (these usually include loan origination fees, progressing and recording fees, points, survey fees, appraisal fees, attorney fees, cost of credit report, title search fees, prepayments for insurance, prepayment of taxes and interest, and mortgage prepayment penalties).
   
2. Learn what the new monthly mortgage payment will be. Each bank or mortgage company should give you a written statement that indicates your new interest rate (should be a fixed interest rate, not an adjustable rate) and monthly mortgage payment, based on at least two options. One option is based on rolling the refinancing fees and closing costs back into the new mortgage. The other option is based on your payment of the refinancing fees and closing costs in cash. By far, the better option is to pay the fees and costs out of pocket rather than rolling them into your refinancing package.
   
3. Compare savings. Determine the total dollar amount of interest you'd save through refinancing at a lower interest rate and compare that to the costs of refinancing. Also, divide the refinancing costs by the amount of savings to determine how long it will take to break even.
   
4. Length of time in the residence. Once you know the break-even point of each loan you have compared, the main consideration should be how long you expect to live in the home. If you are not sure that you will live in the home until the break-even point, it would not be profitable to refinance.

Conclusion
When evaluating whether you should refinance your home mortgage, a number of questions should be asked. If you can answer all of these positively, you might benefit from refinancing. However, if some of the questions cannot be answered positively, refinancing may not be the best option for you.

• Can all refinancing fees and closing costs be paid out-of-pocket?
  
• Can I recoup through savings in monthly payments all refinancing fees and closing costs within three years?
  
• Is the refinancing interest rate 1 percent or more lower than my existing home mortgage rate?
  
• Do I plan to live in the house until I break even?
  
• Is the new interest rate a fixed rate?
  
• Is my prepayment penalty less than an amount equal to three monthly payments?