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Refinancing Your Mortgage

It may be time

In love couple using a tablet computer in their living room

Many homeowners who stay in their homes for more than five years end up refinancing their mortgage at some point. It's often assumed that whenever mortgage rates fall, you should refinance, and that doing so will save you money. But actually, it's not quite that simple. Here's a closer look at when it really makes sense to refinance.

When Rates Are at Least 1% Lower Than Your Current Rate

If you're thinking of refinancing just to save money, then you should wait until interest rates are at least 1% lower than your current rate. For example, if your current mortgage has an interest rate of 4.5%, you should consider refinancing when rates fall below 3.5%.

Why not refinance when rates are higher? Well, when you refinance, you are technically taking out a new home loan, so you will have to pay a mortgage origination fee, along with various fees for property appraisal and credit checks. Typically, you need to take out a loan at 1% below your current interest rate in order to account for these costs. This is just a rough guideline, however. There are mortgage refinance calculators you can use to more accurately estimate what rate makes it worthwhile for you to refinance. 

When You Want To Pay off Your Loan Sooner

Another sign it is a good time to refinance is if you want to pay off your loan sooner. For instance, if you have a 30-year mortgage with 25 years left, but you want to pay it off within the next 15 years, then you may want to refinance to a 15-year mortgage. Mortgages with shorter terms usually come with lower interest rates, so you can save quite a lot with this approach versus simply keeping and overpaying on your 30-year mortgage.

When You Want To Withdraw Some Equity for Other Expenses

Another time to consider refinancing is if you want to access the equity in your home. Some banks offer what's known as a cash-out refinance, which is a loan product designed specifically for this purpose. For example, if you have $60,000 left on your mortgage and $100,000 in equity in your home, you could apply to refinance, taking out a mortgage for $120,000 and putting $60,000 of cash in your pocket. 

Homeowners sometimes use cash-out refinances for home improvements, to pay for educational expenses, or to free up money for other investments.

When You've Reached the Equity Level Needed To Drop PMI

If you put less than 20% down when you purchased your home, then you are probably paying for private mortgage insurance, or PMI, each month. PMI is intended to protect the lender in case you default on your loan. It typically costs you $100 a month or so, and it's included in the payment you make to your mortgage company each month.

If you've reached 20% equity in your home, then you are typically eligible to get rid of PMI, but you often have to go through a mortgage refinance to do it. Wait until rates are low, and apply. You'll not only save on interest, but you won't have to pay for PMI anymore.

A mortgage refinance can be a great way to save money, access the equity in your home, or pay your home off sooner in a structured way. If you're thinking of refinancing, it's worth sitting down with a loan officer to see exactly what rate you qualify for and how much you would save overall. With that information, you'll be prepared to make a smart decision.

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