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Running the Numbers on a Refinancing

April 09, 2012
Jonathan Clements, Director of Financial Education, Citi Personal Wealth Management

With 15-year fixed-rate mortgages available at less than 4% and 30-year fixed-rate mortgages on offer at somewhat above 4%, many homeowners are looking to refinance. Should you join the rush?

All the refinancing activity reflects the "heads I win, tails you lose" advantage enjoyed by fixed-rate mortgage borrowers. If rates rise, borrowers can sit tight with their lower-cost mortgage. But if rates fall, they can refinance and thereby lower their monthly payments.

If you're thinking about refinancing, it might seem pretty easy to figure out whether it's a good idea: You calculate how much it will cost to refinance--and how long it will take to recoup that cost through lower monthly mortgage payments. If you can make back your refinancing costs within two or three years, it may be worth going ahead.

But in making this calculation, watch out for a common pitfall. Imagine that, seven years ago, you took out a 30-year fixed-rate mortgage, which means today you effectively have a 23-year loan. If you take that 23-year loan and refinance it with a new 30-year mortgage, your payments will drop even if the rate is exactly the same. After all, you're taking a 23-year loan and spreading the repayment of the loan's principal balance over 30 years.

What to do? Take the interest rate you will be charged on the refinanced loan and, using one of the many online mortgage-payment calculators, figure out what the monthly payment would be on a 23-year mortgage--and then compare that to your current monthly payment.

If refinancing still looks like a money saver, consider two strategies. You might see if it's worth taking out a 15-year mortgage. Alternatively, you could opt for a 30-year mortgage, but make extra payments each month so that you pay off the new loan in 23 years. Even with those extra payments, your total monthly mortgage payment should still be lower--assuming refinancing is a good deal.

INVESTMENT PRODUCTS: NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE

The information provided here is for informational purposes only. It is not an offer to buy or sell any of the securities, insurance products, investments, or other products named.

There is no guarantee that these strategies will succeed. The strategies do not necessarily represent the experience of other clients, nor do they indicate future performance.

© 2012 Citigroup Inc. Citi Personal Wealth Management is a business of Citigroup Inc., which offersinvestment products through Citigroup Global Markets Inc. ("CGMI"), member SIPC.

Citibank, N.A. and CGMI are affiliated companies under the common control of Citigroup Inc. Citi and Citi with Arc Design are registered service marks of Citigroup Inc. or its affiliates.

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