The Benefits—and Dangers—of Serial Refinancing

Repeatedly nabbing a lower interest rate can pay off, as long as you don’t jump the gun.

Refinancing
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Veera Veeraraghavan has kept a close watch on the fluctuating interest rates for home mortgages, and this year it paid off. When he bought his house in 2009, his 30-year fixed mortgage rate was 5 percent. In March, he refinanced and dropped his rate to 4.12 percent—a move that cost him $2,400 in closing costs but reduced his monthly payment by $400. Then in October, he pounced on a no-fee refinance offer for a fixed 30-year mortgage at 3.5 percent. "For me, it was a matter of locking in a lower interest rate for an extended period of time, and I jumped at both opportunities," says Veeraraghavan, a senior director for the College Board in Washington, D.C.

Like millions of Americans, Veeraraghavan took advantage of consistently dropping mortgage interest rates. Rates have fallen for a 30-year fixed mortgage from about 6 percent in 2008 to 3.5 percent today. The Federal Reserve jumpstarted the decline in September 2008 when it put mortgage giants Fannie Mae and Freddie Mac into conservatorship, which turned the tables for the country's subprime mortgage crisis. Through a process called quantitative easing, the Fed pumped money into the economy by buying $1.25 trillion in mortgage-backed securities from lenders. The Fed's efforts, coupled with the recession and a weak global economy, have led to today's record-low interest rates and a record-high number of repeat refinancers, according to Mike Fratantoni, vice president of research and economics at the Mortgage Bankers Association (MBA).

Refinances currently make up approximately 80 percent of mortgage applications, the MBA reports. "It's not that the market has engineered lower interest rates," explains Keith Gumbinger, vice president of HSH.com, a mortgage information resource. "The Federal Reserve found that the best avenue to stimulate the economy is through housing."

Like Veeraraghavan, some homeowners are eager to refinance with a low- to no-cost closing fee contract. This enables them to reduce their interest rate without upfront costs, and the idea is to recoup the costs, scrape money off the top, and then sell their home.

[Read: Secrets of Successful House Flippers.]

But people who opt for a low- or no-fee refinance—offered by a number of banks these days to attract and retain more customers—will end up paying back the savings over the course of the loan, most likely in the form of a slightly higher interest rate: "Lenders are getting people in the door because people don't want to have to pay that cash out of pocket. But it's important to remember there's no such thing as a free lunch."

Greg McBride, senior financial analyst for Bankrate.com, says a general rule of thumb is that it's worth it to refinance if the homeowner is able to make back their investment within three years or less.

"If your time horizon isn't long enough, you're not going to be able to recoup the cost of refinancing," he says. However, McBride says there can be drawbacks to low- and no-fee refinance offers. "People will say, 'Wow, I can reduce my rate now and not have to pay any money out of pocket. Where do I sign?' But they may be depleting their emergency fund at the same time," he says.

Other refinancers are looking to lower their monthly mortgage payments, so they pay more in closing costs and obtain a better interest rate (typically 0.25 percent lower than the interest rate attached to a no-fee refinance). Michael Lyons, a Realtor-broker in Hollywood, Fla., adopted that approach. He purchased his home in 2004 with a 30-year fixed mortgage at 5.5 percent. He refinanced in 2008 with a 30-year note at 4.25 percent, thinking that would be his only refinance. Then, this year, he had the opportunity to refinance his 30-year fixed rate mortgage at 3.25 percent, and he took it. "At the end of the day, I don't care what someone charges me upfront," Lyons says. "If I pay more upfront but save in the long run, I'd much rather take that option." He says he has no intention of selling his home in the next five years.