Does It Make Sense to Refinance if a Home Has Dropped in Value?

Refinancing can still bring savings even if your home's value has dropped.

Refinancing can still bring savings even if your home's value has dropped.

Refinancing your mortgage loan to one with lower interest rates can result in lower payments; the amount you save depends on the size of your loan and your new rate. But if your home has dropped in value since you purchased it, it makes sense to wonder whether refinancing still makes sense. The good news is that you can still enjoy the savings that come with a refinance even if your home's value has fallen. But qualifying for a refinance might prove more challenging.

Equity

Mortgage lenders typically require that you have at least 20 percent equity in your home before they'll grant you a refinance. This becomes a higher hurdle when your home has lost value since you purchased it. In fact, some homeowners find that they owe more on their homes that what they're currently worth -- their homes are said to be "underwater."

The Financial Benefits of Refinancing

Depending on how much your interest rates drops, you can save a significant amount of money if you refinance your mortgage loan. If you have a 30-year fixed-rate $200,000 mortgage loan with an interest rate of 7 percent, you'll have a monthly mortgage payment of about $1,330. If you refinance that same loan to one with an interest rate of 3.5 percent, your monthly mortgage payment will drop to about $890. That's a monthly savings of about $440 or $5,280 a year.

The Costs of Refinancing

Refinancing isn't free, though, and you won't be able to determine if refinancing your mortgage loan makes financial sense until you know how much you'll pay for your refinance. Homeowners can expect to pay from 3 percent to 6 percent of their mortgage loan's outstanding balance in closing costs, according to the Federal Reserve Board. For a homeowner who owes $200,000, that comes out to closing costs of $6,000 to $12,000.

Is it Financially Worth It?

To determine if your refinance is worth it, compare the money you will save each month with the closing costs you'll have to pay. If you are saving $440 a month and paying closing costs of $6,000, you'll be able to recover these costs in little more than a year. But if you are only saving $100 a month and paying closing costs of $10,000 it will take you more than eight years to repay those closing costs.

About the Author

I'm a veteran freelance writer with more than 15 years experience writing for newspapers, consumer magazines and trade publications. My stories have appeared in the Chicago Tribune, Washington Post, Christian Science Monitor, BusinessWeek Online, Business 2.0 Magazine and many other publications. I am also the managing editor of a real estate magazine based in Chicago and the writer of www.propertycrossroads.com, a blog devoted to residential real estate. This year, my first comic-book series, GEARZ, was published by Blue Water Publishing. The company will be publishing three other of my comic-book mini-series in 2008 and 2009.

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