SANTA CRUZ (December 5, 2009) - Those of us who monitor mortgage rates and follow the Federal Reserve's statements and actions did not expect 30 year fixed mortgage rates to drop to 4.50 percent again (loan amounts under $417,000) but they did briefly, earlier this week. As mentioned here a few weeks ago, because the Fed's purchase of mortgage-backed securities is winding down, rates are expected to rise. While they most certainly will rise, there will be ups and downs along the way (remember the kid with the yo-yo going up the escalator?) and this week has seen a pronounced fall.

That's the good news, the bad news is that by press time (for this column) on Thursday, rates had already increased to 4.75 percent. Rates frequently get jittery around the first week of each month in anticipation of the release of last month's unemployment figures.

Whether rates are moving up or moving down, to refinance or not to refinance is always the question that is asked. A good rule of thumb that I have always used is that if your sole goal is to save money, borrowers should look for a full one percent drop in your 30 year fixed rate. That is, if your 30 year fixed rate is 5.75 percent or higher, refinancing into a rate of 4.75 percent makes sense if you plan on keeping your loan in place for at least two to three years. A prudent borrower will not just look at the mortgage payment savings because the new loan will need 30 years to payoff in full and the borrower's current loan may only have 25 years to go. Comparing the mortgage payments does not give the true savings. Borrowers that are focused on cash flow will look strictly at the monthly obligation, regardless of how many years it will take to pay back the mortgage.

To explain, let's just look at the basics: a $400,000 loan at 5.75 percent requires an interest payment of $1916 per month (plus a principal payment of $418). Refinancing into a 4.75 percent loan drops the interest portion of the mortgage payment to $1583 for a $332 per month savings in just mortgage interest. Keep in mind that the interest portion of the mortgage payment will drop a little each month through the life of the loan as the principal is chipped away. After five years, the loan balance will have dropped to $366,000 and the interest portion of the mortgage will drop to $1449 per month.

The closing costs on a $400,000 refinance will come to somewhere between $7,000 - $7,500. This includes the title and escrow fees, lender fees, appraisal fee and a loan origination fee of one point. From an investment standpoint, the borrower has to ask himself if investing $7,500 today makes sense if he is going to be saving $332 per month. The answer can be calculated by dividing the $7500 cost by the $332 per month savings. The result is 23 months. That is, if he keeps this loan in place for at least 23 months, the investment will have been worth it. Tax savings and other considerations will alter the minimum number of months required to keep the loan in place for a refinance to make sense.

Of course there are many other reasons to refinance: to pay back the loan sooner, to create cash, to get out of an adjustable rate mortgage and into a secure fixed rate mortgage, divorce, estate planning, etc. One recent client wants to refinance into a 30 year fixed rate mortgage with the option to pay just the monthly interest payment. He likes this loan because it allows the mortgage payments to drop when he pays down the principal with his bonuses from work. The traditional 30 year fixed rate requires the mortgage payment to remain the same until the mortgage is paid in full.

This column is written every Saturday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 of email him at Peter@SantaCruzHomeFinance.com.