Are you on the fence about refinancing your mortgage? Good news: There are some signs to help you figure out if refinancing (the process of paying off your existing mortgage with a new one) is a smart idea for you.
Just note: lenders usually require that you have at least 5 percent equity accumulated in your property to be eligible to refinance your mortgage, according to Fannie Mae, a government-sponsored national mortgage finance company.
Are you eligible? Here are five more signs it may be time to refinance your mortgage.
Sign #1 - You Can Get a Lower Interest Rate
What's the first tell-tale sign that it's time to refinance? If you can snag an interest rate lower than what you currently have.
And chances are, you can.
"Interest rates are at a historic low right now, so it may be a good time to go ahead and [refinance]," says Shah Tehrany, a managing director at Franklin First Financial, a nationwide mortgage banker. "Right now, at 5 percent on a fixed rate 30-year loan or 4 percent on a fixed rate 15-year loan, you may want to seriously look into seeing if you can get a lower rate."
Tehrany adds that you should try to get a refinance mortgage rate that is at least 1 percent lower than your current rate. This way, you're getting a significant savings that will hopefully outweigh the refinancing costs—which aren't cheap.
According to the central bank of the United States, also known as the Federal Reserve, refinancing costs can range from 3 to 6 percent of your outstanding principal.
Sign #2 - You Have an Adjustable-Rate Mortgage
There are two types of mortgages: fixed rate and adjustable rate. If you have the latter, it could be a sign that it's time to refinance and switch to a fixed-mortgage rate.
Here's why: With an adjustable rate mortgage (ARM), the interest rate fluctuates over the life of the loan, based on market conditions, according to the Federal Reserve. This means that while your interest rate could go down significantly, it could also take a sharp hike up. As you might imagine, the unpredictability can be unnerving.
For this reason - and the historically low interest rates - Tehrany says you may want to lock in a low fixed rate, rather than taking a chance with the rate fluctuations of an ARM.
Moreover, a fixed-rate loan provides the stability and predictability of knowing exactly what your mortgage payment will be for the duration of the loan. Thus, managing your finances will most likely be easier, because you'll know just how much to set aside each month for your mortgage payment. For example, if you pay $1,700 each month for your mortgage, it will stay just that.
Sign #3 - You Have Significantly More Money
Do you have some extra cash coming in, but you're not quite sure what to do with it?
You could put that dough to good use and refinance your loan from a 30-year loan to a 20-, 15-, or 10-year loan.
This may be a good decision because 30-year loans tend to have lower monthly payments, but higher interest rates, while 20, 15, and 10-year loans have higher monthly payments, but lower interest rates, according to Fannie Mae. Thus, by using your extra cash flow to refinance to a shorter term loan, you could save quite a bit of money.
Compare, for example, a fixed-rate loan of $200,000 at 6 percent for 30 years, with a fixed-rate loan at 5.5 percent for 15 years. You'll pay $231,640 in interest with a 30-year loan at 6 percent interest, and $94,120 in interest with a 15-year loan at 5.5 percent interest.
As you can see, that's a huge chunk of change you could be saving with a shorter loan.
Of course, you should only consider this option if your finances are stable. If you don't think you can afford the higher monthly payments for the life of the loan, it may not be worth it to refinance to a shorter term.
Sign #4 - Your Credit Score Has Improved
Did you have a history of credit problems when you initially took out your loan? Has your credit score improved since then? If so, you may be a great candidate for refinancing.
Just consider this: "A bad score can show recklessness, which doesn't seem reliable to lenders," says Tehrany. On the other hand, a good score shows dependability - like being able to pay your mortgage bills each month.
So, if your credit score is on the "up and up," you could refinance your mortgage and potentially receive a more competitive interest rate, according to Fannie Mae.
How do you know, though, if your credit score has improved? By law, you are allowed one free annual report, which can be retrieved at AnnualCreditReport.com, according to the Federal Trade Commission.
If your credit has improved, you should talk to a lender about refinancing into a loan that recognizes your new credit worthiness, Fannie Mae notes.
Sign #5 - You Have a Second Mortgage and You Want to Consolidate
Do you have a second mortgage you're chipping away at, and want to consolidate your loans? If the answer is an enthusiastic "yes," then it may be time to refinance.
"Debt consolidation" as it's also called, is the process of combining all your debts into a single monthly payment.
So why might this be a good financial decision?
"Because when you have two mortgages, the second can have a higher interest rate," says Tehrany. For example, you may have a first mortgage with 4.5 percent interest, and a second one with a 5.5 percent interest rate. "Combine the two though, and you could have a lower rate, which can save you money."
But that's not all—there's the perk of convenience, too. This is especially true if you have trouble keeping track of your finances because when you consolidate, you have just one bill, one due date, and one lender to deal with.
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