Deciding whether to refinance your mortgage

When you take out a mortgage to buy a home, you won't necessarily have to stick with the same terms for the life of the loan. Refinancing the mortgage can help make it more affordable or save you a considerable amount of money.

According to the most recent Fannie Mae Lender Sentiment Survey, refinance mortgages experienced a drop in popularity in recent years due to a gradual increase in mortgage rates. However, lenders report that homeowners are showing more interest in refinancing as rates again trend downward.

When determining the best time to refinance a mortgage, keep an eye out for such dips in available rates. Michele Lerner, writing for the mortgage site, says that while several factors determine whether rates will increase or decrease, you can get a sense of where they might be heading by tracking economic factors such as jobs reports and statements from the Federal Reserve.

You may want to start the refinance process early and have your lender hold the paperwork until you're ready to agree to the new loan terms. Since it can take several weeks for the lender to approve the loan, you may miss the most favorable rate if the process takes too long.

Getting a lower rate is one of the most common reasons homeowners opt to refinance. The financial site Investopedia says a lower rate can reduce your monthly payments and allow you to contribute more of each month's payment toward the principal, which in turn builds up equity in your property at a faster pace.

You may be able to get a lower rate if the options are simply better than what was available when you took out the mortgage, but you're also more likely to get a better rate if your financial history has improved. Kailey Fralick, writing for the financial site The Motely Fool, says a higher income helps assure lenders that you'll be able to make your mortgage payments while a better credit score can demonstrate that you've become more fiscally responsible and less of a risk.

Refinancing can also allow you to change the length of the loan. Investopedia says you may go for a shorter timeframe to pay off your home sooner; if interest rates have fallen, you may be able to accomplish this without a significant change to your monthly payments.

Conversely, you may opt for a longer loan to help bring down how much you'll owe each month, freeing up more money for other expenses. Fralick says this might end up costing you more money long-term, since you'll need to pay any necessary fees to refinance and will be paying more in interest by extending the mortgage beyond its initial end date. However, you can still opt to contribute extra money toward the mortgage each month.

You can also choose to change the mortgage from a fixed rate to an adjustable rate, or vice versa, when refinancing. The financial site NerdWallet says changing to a fixed rate can be a useful step if you plan on staying in the property for a long time, since you can lock in a favorable rate for the duration of the mortgage.

If you plan to move out within a few years, changing to an adjustable rate mortgage might be the better move. This type of mortgage has an initial period with a lower rate than a comparable fixed rate mortgage; if you plan to sell your home before the adjustable period kicks in, you can easily save a good deal of money on interest.

Cash-out refinancing allows you to receive a lump sum of money. Ellen Chang, writing for the financial site Bankrate, says this process replaces your current mortgage with one worth more than the outstanding balance. The difference is credited to the borrower, and often used to finance home improvements or other large expenditures.

Homeowners should be especially cautious when considering cash-out refinancing. Using this method to settle debt can be risky, since it could potentially replace an unsecured debt with a secured one; if you can't keep up with payments, you may lose your home. Investopedia advises against this reason for refinancing unless you can also reign in your spending and avoid racking up large debts again.

Before committing to a refinance mortgage, consider whether doing so will be financially savvy. Lerner says you should also consider what goals you would like to accomplish, such as whether you want to pay off the home more quickly or reduce your monthly payments.

The new mortgage will come with closing costs, which typically fall between 3 and 6 percent of the loan's principal. You should plan to stay in your home for at least as long as it takes to reach the break-even point, where the money you save offsets the amount you spent. Chang says you can calculate this point by dividing the closing costs by the amount you'll be able to save each month.


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