When mortgage rates are low, or lower than you’re currently paying, refinancing can be the right thing to do. But you’ve got to be wary of the come-ons. And you’ve got to understand the numbers — people don’t.

In my previous work in the real estate industry, I witnessed people who, after “owning” for 30+ years, sold their homes and walked out of the closing room without a penny to show for three decades worth of home mortgage payments. Over that time, they had at apparently every opportunity, cashed out equity. What they spent it on, I haven’t the foggiest — perhaps they did something smart with it. But probably, they bought boats and cars and vacations to Mexico, because that’s what most people do.

Lesson 1: Only take out your equity if you have a damn good use for it. A damn good use would be, ideally, something that generates positive cash-flow for you. Except for the direst of emergencies, you shouldn’t be spending that equity money on anything that is immediately consumed, or that depreciates in value.

We bought our house in February of 2008, and are now looking at the prospects for refinancing. We can now easily obtain a rate 1% better than our existing rate. Now, we’re not going to get rich off of the reduction (about $75) in monthly payments.

I asked what it would cost to knock another 1/2% off the rate, and was told that it would be about 2 points. Here’s where it gets even better: the mortgage guy told me that, “We think rates are going to be even lower towards the end of the year, and I don’t think it’s a great idea to pay for the rate now, if you can get it for free in November.” Slick, eh? Why would you want to pay for something that you can get for free?

Lesson 2: Refinancing now means that you have 360 more mortgage payments to make. Which I suppose is OK, until you do it again next year, and the year after, and again in 2015, etc. I don’t want to make mortgage payments forever, in fact, I don’t want to make a mortgage payment after I’m 45.  And you shouldn’t, either. I understand that the easiest way to be able to retire comfortably is to make sure you’re not locked into massive mortgage payments and other debt-servicing through your golden years.

If you want to make mortgage payments forever, you’re better off renting/leasing.  Falling for the “you can get it for free later” (which, I might add is anything but certain in this market) is the first step towards effectively renting your house from the bank. Pretty soon, you’ve lived in the house for 33 years and don’t have a dime of equity. By minimizing your monthly payments, you’re actually maximizing your indebtedness.  Unless you’re drastically axing your interest rate, you’re not going to get rich off the difference in monthly payments. So stop focusing on the monthly payments.

Lesson 3: If you put Lessons 1 and 2 together, math happens!

As long as you’re not taking cash out of equity, each time you refinance, the mortgage amount should be smaller than it previously was. If you’re getting a lower rate, and a lower balance, consider a note of shorter duration. If you can stomach an increase in your monthly payment, a 15-year mortgage would be worth considering,although you can probably get a 20- or 25-year note (and pay down your debt/build equity faster) for about the same as your currently paying on a higher-interest 30-year note.

If you had $15,000 lying around and I could guarantee you 18% over the next 6 years (compounded annually would give you $40,000) would you take it? So you don’t have $15,000 lying around, OK, you’re not alone. But you probably have $300 and if you budget your expenses, you’ll have another $300 next month, and so on.

A 15-year mortgage will going to cost you more each month, even if the rate is lower, but significantly more of your payment goes to principal, which means you build equity much faster. I ran the amortization schedule for a $150,000 mortgage for 30 years and 15 years at 4.5%. (I like the amortization calculator at Bretwhissel.net) Over a relatively short period of time (7 years) you’d pay off about 4 times as much principal on the note of shorter duration. For the examples, it would make the difference between about $19k worth of equity vs. $58k worth of equity. That $39,000 difference would cost about $15,000, and that comes from the extra $300/month that you paid.

You now owe $40,000 less to the bank than you otherwise would!

This means more proceeds if you sell, more equity in case of a dire emergency, and a greater ability to weather a stagnant or declining economy.  If home values rise over that time, you’ll just have that much more money when you eventually sell.  In either case, bad or good, you’re going to be better off in the long-run by making some small sacrifices in the short-run.