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During this period of prolonged artificially low interest rates, 80% of loan applications submitted nationwide are for a refinance. This financial adjustment may be a prudent decision for the well-informed homeowner who has an equity in his property, but the majority of Americans are relying on the risky calculations of financial advisers looking to profit from homeowners’ ignorance.

Hundreds of financial planning websites have sprung up offering broad, hasty recommendations for a decision that requires a specific, thorough understanding of each individual’s circumstance. Refinancing generally costs anywhere from 3% to 6% of the outstanding loan principal — a major undertaking that is not to be casually entered into without a proper due diligence investigation.

Many banks use these “refi calculators” as lead generators, connecting potential borrowers to over-zealous banks. They use the “1% rule,” telling homeowners refinancing is an invariably prudent option so long as it knocks at least one percentage point off their current interest rate.

However, this reductionist conclusion neglects the necessary comparison of a homeowner’s monthly savings to the closing costs for the refinance — a fact which may suggest a refinance won’t ultimately save much, and may even lose money for the homeowner. An intelligent decision must also take into account a homeowner’s tax rate, inflation expectations and how long they plan to continue occupying their home. Thus, the one-size-fits-all calculations provided by the online refi calculators are uselessly generic at best, misleading at worst.

The National Bureau of Economic Research (NBER) uses a formula that more accurately reflects a homeowner’s refinance options, and honestly reflects when a refinance is not in the best financial interest of the homeowner. The government algorithm compares the loan size, the homeowner’s marginal tax rate, the expected inflation rate over the term of the loan and how long the homeowner plans on staying put – the factors necessary to make an informed decision, one way or the other. Not surprisingly, the government calculator offers a more lucid snap-shot of a homeowner’s options, often suggesting a refinance is advantageous only if interest rates get lower.

first tuesday take: Agents and brokers need to aggressively encourage homeowners to seek free counseling from a housing finance agency approved by the Department of Housing and Urban Development (HUD) before making any refinancing decisions.

Agents and brokers can also educate the community by addressing the refinance frenzy in FARM letters, financial planning seminars and through sound counseling with homeowners considering a loan modification. [For templates and examples of FARM letters, see the September 2010 first tuesday FARM letter page.]

Re: “Refinancing: Whom can you trust?” from the Wall Street Journal; and

Reasons not to refinance a mortgage” from the New York Times