SANTA CRUZ (January 4, 2009) - The Fed’s promise to spend $500 billion to buy mortgage-backed securities beginning in January has created historically low mortgage rates. For prospective homebuyers and prudent homeowners it could be a chance of a life time! Whether to refinance or not is on everyone’s mind and is not a decision to be taken lightly.

Refinancing is the process of placing a loan on real estate for any reason other than for a purchase. A refinance transaction occurs when a loan is placed on a property even when there is no existing loan. Most commonly, a refinance is the process of replacing an existing loan on a property with another loan. There are many considerations to take into account (both pro and con) before jumping into a refinance transaction.

Between 1997 and 2005, the average home price in Santa Cruz County rose from $304,000 to $835,000. That is a spectacular 275 percent increase or 13.5 percent per year! During this period of rapid appreciation, many homeowners were using their homes as a ATM to create cash. This was accomplished by refinancing out of the existing mortgage on the home and into a new, larger one. The difference between the two loan amounts was returned to the homeowner in the form of a cashier’s check. It was kind of like winning the lotto.

More often than not, the new mortgage will put off the day when the home will be mortgage free because the new loan starts the 30 year term all over again. While some homeowners elect a 15 year fixed rate, many homeowners do not care about ever paying back their mortgage and go for the new mortgage that creates cash with the lowest monthly payments possible.

If interest rates drop enough, homeowners can create cash while keeping their mortgage payments the same. It feels like free money but the downside is often that the pay off date of the loan is pushed out further.

At the other end of the spectrum are the most conservative homeowners who refinance with one thought in mind and that is to pay off their mortgage as quickly as possible. Homeowners accepting a 15 year mortgage will enjoy a lower rate (vs. the 30 year rate) but must be willing to accept mortgage payments that are nearly 50 percent larger. Compare a $300,000 mortgage at last week’s 30 year fixed rate of 5 percent with a payment of $1610 to a 15 year mortgage at 4.75 percent with a $2333 monthly principal and interest payment. However, if taken all the way to the end, the 30 year mortgage will require a total interest of $279,600 and the 15 year mortgage will require just $119,900.

Closing costs, current interest rate, loan size, loan-to-value ratio, as well as the homeowners’ documentable income and credit history will all play a significant role in a refinance. Making the decision to refinance or not requires considerable thought and preparation and is clearly not best for everyone. Nor will refinancing even be an option for everyone. With the drop in values that we have experienced here, many homeowners will be prohibited from refinancing. Only those who still have equity (that is the difference between the home’s value and the total mortgage(s)) may even consider refinancing.

Creating cash, lowering payments or hastening the day your mortgage is paid off are key reasons to consider refinancing. My future columns will go into the pros and cons of refinancing and some of the legal issues to consider.

This column is written every Sunday 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.