Is It Time for Your Clients to Refinance?

By Ken Berry

Mortgage rates throughout the country have reached historic lows. The going rate for a conventional, thirty-year mortgage has dipped below 4.5 percent, and the rates for fifteen-year mortgages are even lower. Given the current interest rate environment, many of your clients will be tempted to refinance their existing mortgages.

Caution: Despite the rock-bottom rates, refinancing isn't always advisable. Help your clients by doing a thorough analysis, taking into account the tax implications, the monthly savings available with a lower interest rate, and the length of the time the client expects to remain in the home. The key is to find the break-even point, which is the number of months your client will need to live in the home after refinancing in order to recover the costs of refinancing.  

Let's start with the tax basics. Generally, a taxpayer can deduct the mortgage interest paid on acquisition debt of up to $1 million used to buy, build, or substantially improve a principal residence or one other home, such as a vacation home. This includes acquisition debt paid on a refinanced mortgage. However, if the taxpayer incurs points on the refinancing, the points must be amortized over the length of the loan. Each point is equal to 1 percent of the mortgage amount.

Even if the taxpayer can deduct all of the mortgage interest, a lower interest rate will eventually result in smaller interest deductions. This means that a client might actually save less over the term of the loan than he or she might think.   

Of course, online calculators can do the grunt work for you, but you can also use a quick "back-of-the-envelope" formula to estimate the break-even point for a client. Follow these five steps:

  1. Add up all refinancing expenses, including points, application fees, attorney fees, loan origination fees, additional insurance, appraisals, inspections, recording and survey fees, title insurance, credit reports, and so on.
  2. Figure out the monthly savings by subtracting the client's current monthly payment from the amount that will be due with a refinanced loan. 
  3. Multiply the monthly savings by the client's combined federal and state income tax rate.

  4. Subtract the tax cost from the monthly savings to arrive at the net savings.

  5. Divide the total cost by the net savings to determine the number of months it will take to pay off the refinancing expenses. This is the break-even point; in other words, any future savings are gravy.

Example: The Smiths will save $500 a month by refinancing, and the total cost is $8,000. It will take the couple sixteen months to recoup the cost of refinancing. If the Smiths plan on moving in about a year, it's not worthwhile for them to refinance. Conversely, if they expect to stay in the home for two years or more, refinancing probably makes sense.

Additional factors also can come into play. For instance, if the existing mortgage contains a prepayment penalty clause, it will effectively increase the length of time it will take for the client to break even. Also, if a client chooses a mortgage that does not require points, the rate likely will be slightly higher than the advertised rate.

Best approach: Steer your clients in the right direction by crunching the numbers for them. If refinancing is a viable option, caution clients against fly-by-night operations that are offering "sweetheart" deals that are too good to be true. Advise them to use a reputable lender with a proven track record.

Related articles:


You may like these other stories...

Starting in January 2015, the IRS will limit the number of refunds that are electronically deposited into a single financial account or pre-paid debit card to three, as part of the agency’s effort to crack down on...
House proposes $10.5B, eight-month highway billThe House Ways and Means Committee proposed a transportation funding bill on Tuesday that calls for a temporary extension of current transportation funding levels until May 31,...
Swiss banks threaten freeze on US accounts over tax evasionJames Shotter of the Financial Times reported on Monday that several Swiss banks have threatened to freeze American clients’ accounts unless they prove they...

Upcoming CPE Webinars

Jul 16
Hand off work to others with finesse and success. Kristen Rampe, CPA will share how to ensure delegated work is properly handled from start to finish in this content-rich one hour webinar.
Jul 17
This webcast will cover the preparation of the statement of cash flows and focus on accounting and disclosure policies for other important issues described below.
Jul 23
We can’t deny a great divide exists between the expectations and workplace needs of Baby Boomers and Millennials. To create thriving organizational performance, we need to shift the way in which we groom future leaders.
Jul 24
In this presentation Excel expert David Ringstrom, CPA revisits the Excel feature you should be using, but probably aren't. The Table feature offers the ability to both boost the integrity of your spreadsheets, but reduce maintenance as well.