When to refinance your mortgage?

The usual trigger for people to start thinking about a refinance is when they notice mortgage rates falling below their current loan rate. But there are other good reasons to refinance:

• If you're looking to pay off the loan quicker with a shorter term.

• You've gained enough equity in your home to refinance into a loan without mortgage insurance.

• You're looking to tap a bit of your home equity with a cash-out refinance.

To know if it’s the right time to refinance, first determine how long you plan to stay in your home, consider your financial goals and know your credit score. All these things, along with current refinance interest rates, should play a role in your decision about whether — and when — to refinance.

What is a good mortgage rate?

Avoid focusing too much on a low mortgage rate that you read about or see advertised. Mortgage refinance rates change throughout the day, every day. And the rate you’re quoted may be higher or lower than a rate published at any given time.

Your mortgage refinance rate is primarily based on your credit score and the equity you have in your home.

You’re more likely to get a competitive rate as long as your credit score is good and you have proof of steady income.

Is it worth refinancing for half a percent?

An often-quoted rule of thumb has said that if mortgage rates are lower than your current rate by 1% or more, it might be a good idea to refinance. But that's traditional thinking, like saying you need a 20% down payment to buy a house. Such broad generalizations often don't work for big-money decisions. A half-point improvement in your rate might even make sense.

To determine if refinancing makes financial sense for you, it's a good idea to run the real numbers with refinance mortgage calculator.

To calculate your potential savings, you’ll need to add up the costs of refinancing, such as an appraisal, a credit check, origination fees and closing costs. Also, check whether you face a penalty for paying off your current loan early. Then, when you find out what interest rate you could qualify for on a new loan, you’ll be able to calculate your new monthly payment and see how much, if anything, you’ll save each month.

You’ll also want to consider whether you have at least 20% equity — the difference between its market value and what you owe — in your home. Check the property values in your neighborhood to determine how much your home might appraise for now or consult a local real estate agent.

Home equity matters because lenders usually require mortgage insurance if you have less than 20% equity. It protects their financial interests in the event you default. Mortgage insurance isn't cheap, and it's built into your monthly payment, so be sure you wrap it into calculations of potential refinance savings.

Once you have a good idea of the costs of refinancing, you can compare your “all-in” monthly payment with what you currently pay.

Will the savings be enough to make refinancing worthwhile?

You’ll spend an average of 2% to 5% of the loan amount in closing costs, so you want to figure out how long it will take for monthly savings to recoup those costs. This is often called the “break-even point” of a mortgage refinance. For instance, it would take 30 months to break even on $3,000 in closing costs if your monthly payment drops by $100. If you move during those 30 months, you’ll lose money in a refinance.

Think about whether your current home will fit your lifestyle in the future. If you’re close to starting a family or having an empty nest, and you refinance now, there’s a chance you won’t stay in your home long enough to break even on the costs.

Homeowners who have already paid off a significant amount of principal should also think carefully before jumping into a refinance.

If you’re already 10 or more years into your loan, refinancing to a new 30-year or even 20-year loan — even if it lowers your rate considerably — tax on interest costs. That’s because interest payments are front-loaded; the longer you’ve been paying your mortgage, the more of each payment goes toward the principal instead of interest.

Ask your lender to run the numbers on a loan term equal to the number of years you have remaining on your current mortgage. You might reduce your mortgage rate, lower your payment, and save a great deal of interest by not extending your loan term.

Is it time to change the type of loan I have?

Take your prediction on how long you’ll stay in your current home, then think about the details of your current mortgage. How those factors play off each other could have a role in your refinance decision.

Let’s say you bought a home with an adjustable-rate mortgage for an initial term of five years at around 3%. You plan to stay put for several more years. If you’re nearing the time when the adjustable rate can reset and move higher, you might benefit from refinancing to a fixed-rate mortgage to get an interest rate that won’t fluctuate.

Or, if you know you’ll be moving in a few years, refinancing to an ARM from a longer-term fixed loan might help you save some money because lenders usually offer lower interest rates on those loans.

What's changed from your last loan closing?

Has your credit score and payment history improved since you got your mortgage? If so, you might qualify for a better interest rate on a refinance, which will help you save more per month and break even sooner.

On the other hand, hitting a rough financial patch (or two) can do a number on your credit, and that affects your ability to qualify for a refinance loan and get a good rate. If you’ve been late on a credit card payment, bought a new car or taken on student loans, your credit score might be lower than it was when you took out your original mortgage. Before refinancing, you might want to do some credit repair.

That could include waiting to apply for a refinance until after reducing some debt, making sure there are no mistakes in your credit report and allowing your credit history to heal over time with a period of prompt payments.

Or, when you determine how much you pay in credit card and other high-interest debt each month, you may find the money you’d spend on closing costs could be better spent paying down those bills instead of refinancing your home.

If you don’t qualify for a conventional refinance loan, special Fannie Mae and Freddie Mac refinance programs might work for you.

Saving money on your mortgage helps you build wealth. If now isn’t the ideal time for you to refinance, keep plugging away on your current mortgage payments and improving your credit so you’ll be ready to strike when the time is right.