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3 Signs You Need to Refinance Your Mortgage

By Matthew Frankel, CFP® - Updated Oct 27, 2016 at 3:34PM

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If these situations apply to you, refinancing could be your best option.

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Have you considered refinancing your mortgage? If so, you're not alone – in fact, 56.7% of current mortgage activity comes from refinancing, thanks to historically low interest rates and easing credit standards over the past several years. With that in mind, if any of these three things apply to you, it may be time to look into refinancing your own mortgage.

Your interest rate is too high, or isn't fixed
The most obvious reason to refinance is to take advantage of historically low interest rates, especially if your current rate is significantly higher than what's available today. As of this writing, the national averages are:

Loan Type

Average Interest Rate

30-year fixed

3.68%

15-year fixed

2.96%

5-year adjustable rate

2.92%

Source: Freddie Mac.

Also keep in mind that you can likely do even better if you have excellent credit. According to myFICO.com, the average rate for a borrower with a FICO score above 760 is just 3.34% for a 30-year and 2.73% for a 15-year mortgage. Comparing the current rates to those over the past 20 years, and you can see just how cheap mortgages are now.

US 30 Year Mortgage Rate Chart

If you haven't explored the option of refinancing, you might be surprised at just how much you could save – even if you don't think your current interest rate is that bad.

For example, let's say that you bought your house in 2009 and that your interest rate is 5.5% on a 30-year loan with an original balance of $300,000. According to an amortization calculator, your monthly principal and interest payments would be $1,703, and your remaining balance would be $271,608.

Refinancing this into a new 30-year loan with an average rate would make your payment $1,377, a savings of $326 per month. And, even including the extra five years you'll be paying on the house, you'll save more than $21,000 in interest.

Be aware, however, that refinancing is only worth it if you'll be in the house long enough for the savings to justify the costs. Refinancing mortgages have closing costs, just like purchasing mortgages. To calculate your breakeven point, simply divide the closing costs by your monthly savings. If you plan on being in the house longer than this amount of time, refinancing could be a smart move.

You need cash or you have a lot of credit card debt

If you need to make a big purchase or have a lot of high-interest debt, doing a "cash out" refinancing is almost always a better option than buying something with a credit card, or consolidating your debt with an unsecured personal loan or borrowing from your retirement savings.

Basically, a cash out refinancing involves obtaining a loan for more than your current mortgage balance and receiving the difference in cash. You can generally do this as long as the new loan represents 80% of your home's value or less.

With a cash-out refinance, you're likely to get a much better interest rate than you would with any other form of borrowing, but there are a few things to keep in mind. First, even though your interest rate will be relatively low, you're financing the debt over 30 years so your total interest cost could be higher than other borrowing options.

Also, and most importantly, when you refinance and use the proceeds to pay for large purchases or pay down credit card debt, keep in mind that your home is now being used as collateral for the loan. Credit cards are an unsecured form of borrowing – that is, if you don't pay your credit cards, you'll start to get collection notices and your bad payment history will crush your credit score. However, if you don't pay your refinance mortgage, non-payment could result in losing your house. For this reason, it's extra important not to borrow more than you're comfortable with when refinancing.

You've had an FHA loan for several years, and you now have equity in your home
FHA loans are great products for those who need them, as they allow borrowers with lower credit scores to buy homes without a large down payment. Unfortunately, this comes at a price. FHA loans have steep mortgage insurance premiums, and generally cannot be cancelled for the life of the loan, no matter how much you pay down.

If your remaining loan balance is less than 80% of your home's value, you may be able to refinance and drop the mortgage insurance for good. Currently, FHA mortgage insurance is 0.85% of your loan's balance per year on a 30-year loan with 3.5% down, so if you still have a loan balance of $250,000, this translates to $2,125 in annual savings, and that's in addition to any additional benefits from the current low interest rates.

Shop around
As a final point, if you do decide to refinance, it's important to shop around for the best deal. Thanks to a provision in the FICO credit scoring formula, any mortgage applications that occur within a normal shopping period (two weeks to 45 days, depending on the specific scoring model) will count as a single inquiry. So, you can apply for one mortgage or 10 – you don't have to worry about the effect on your credit score.

The reasons I emphasize this is that you may be surprised how much of a difference a slightly lower interest rate can make. For example, if you're trying to refinance a $250,000 mortgage, let's say that you're offered 30-year loans with interest rates of 4% and 4.1% from two different lenders. These may look to close to make a difference, but the lower rate translates to more than $5,000 in savings over the life of the loan.

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