When rates came down significantly after late 1994, many homeowners with older fixed-rate mortgages sought refinancing with a lower rate loan. Some with adjustable-rate financing sought to lock in a low fixedrate for the long term or refinance to a lower variable rate.

Refinancing a home mortgage can result in a significant monthly savings in mortgage costs. A rule of thumb says that refinancing makes sense ifthe current mortgage rate is at least two percentage points lower than your existing mortgage rate and you plan to stay in the home for at least two years. This “rule” is based on the fact that you will incur new closingcosts by refinancing.

In fact, the decision to refinance should not be made solely according to an arbitrary rule. Rather, it should be made only after undertaking acareful financial analysis.

The costs of refinancing – prepayment penalty (if any) on the old mortgage, application fees, appraisal costs, “points” (prepaid interest), survey costs, recording fees, among other expenses – need to be taken into account. Some of these costs may be waived or refunded by the lender. Youmay also be able to save additional closing costs by refinancing with your current lender. Be sure to shop around to make sure you are getting thebest overall deal.

After reviewing the costs of refinancing, weigh the income-tax consequences of refinancing. Be aware that refinancing may yield someunexpected tax write-offs and limitations.

If you pay a prepayment penalty, it may be deductible as mortgage interest.

If you incurred any mortgage points that you couldn’t deduct in full when you took out the old mortgage, the points had to be amortized and deducted over the life of the mortgage. When you refinance that mortgage, theremaining unamortized points may be deducted in full.

Also consider that if your refinancing means paying less annual interest, you will have a smaller mortgage interest deduction for tax purposes.

Result: You may have to increase your withholding or estimated tax payments to account for the change.

Also, if you are paying points on the newly refinanced mortgage, be advised that, unlike points paid on your original home mortgage which may be fully deductible in the year paid, your refinancing-related points are generally deductible over the amortizable life of the new loan. Where therefinancing is incurred for home improvements, points paid from separate funds may be deducted currently.

Finally, you must determine whether to take out a fixed-rate mortgage or an adjustable rate mortgage. Each comes in a number of variations, andwhether one form is preferable to another depends on factors such as the longer-term trend of interest rates and, more importantly, your personal circumstances. One big factor to consider is: how long do you plan to stayin your home? These are just a few of the points that should be considered prior to refinancing your existing mortgage. Consult your tax advisor regardingpotential considerations and restrictions that may apply to your situation including qualifying as acquisition indebtedness versus home equity indebtedness.

(Alan S. Moore is a financial advisor of Legg Mason Wood Walker Inc., adiversified financial services and securities brokerage firm that is a member of the New York Stock Exchange, Inc. and SIPC.)

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