Time to Refinance? 4 Questions to Ask

Mortgage rates are at historic lows, butdoes that mean you should refinance? Five years ago, New Jersey homeowner Bill Allard bought a house with a 30-year fixed mortgage at a rate of 5.75 percent. But with mortgage rates now below 5 percent, he's wondering if he should refinance his loan. "I could get a lower rate and my monthly payments will be less, but will I come out ahead in the long run?" he asks.

Mortgage rates are at rock-bottom lows these days, meaning it's a good time for many homeowners to refinance their mortgages. But it's not always the best financial decision. In some cases, you may be better off sticking with your current mortgage.

The best way to determine whether now is the right time to refinance is to first ask yourself these four questions.

1. Are interest rates headed up or down?

If you think interest rates are on the way up, refinancing now will allow you to lock in a lower rate. If you have an adjustable-rate mortgage (ARM), you can take the opportunity to switch to a fixed-rate loan. That way, you don't have to worry about your payments climbing if interest rates rise.

If, like Allard, you already have a fixed-rate mortgage at a higher rate, refinancing can lower your monthly payments. But that doesn't always make it the right move. You still need to ask more questions.

2. Will it save me money in the long run?

True, lowering your interest rate will reduce your monthly payments -- but it won't necessarily save you money in the long run. Let's say you have 20 years left on your current loan. If you refinance now into a new 30-year mortgage with a lower interest rate, you've just added 10 years of interest payments, which may end up costing you more over the life of the new loan.

Do the calculations to determine whether refinancing into another 30-year mortgage will reduce your overall loan balance. If not, you may want to consider a new 15-, 20- or 25-year loan instead of another 30-year loan.

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3. Has my income and/or credit rating improved?

If your financial standing has improved and you're able to increase the amount of your monthly payment, you can refinance in order to build your home equity faster. "Converting your loan from a 30-year to a 15-year loan, or changing your payments from monthly to bi-monthly, will pay off your loan much faster and save you thousands of dollars in interest payments," says J.J. Sims, owner of ABC Mortgage in Minneapolis.

However, if your income and your credit score aren't what they used to be, those factors could keep you from qualifying for a low enough interest rate to make refinancing a viable option. Having too many credit cards, maintaining balances that are too high and having too many other types of loans will make you a high risk in a lender's eyes, and refinancing could cost you more money instead of saving you some.

If you're currently underwater on your home, a refinance is difficult but not out of the question. You may be able to get help through the government's Home Affordable Refinance Program (HARP).

4. How long do I plan to stay in my house?

Typically, you have to live in your house for a while for refinancing to pay off. When you're deciding whether to refinance, you should consider how many months of lower payments it will take to recoup the closing costs of the new mortgage. Bankrate does an annual survey of closing costs; the national average this year on a $200,000 mortgage, including loan origination and title fees, is $3,741. (Fees not included are taxes, insurance and prepaid items like homeowner association dues.) So, for example, if your monthly payment goes down by $150, it would take 25 months of lower payments to recoup the average closing costs.

In the end, that's why Allard decided not to refinance. His job may require him to move within the next 12 months. "Refinancing does not make sense if I put the house back on the market," he says. However, for homeowners in good financial shape who are planning to remain in their home for a while, it may be a good time to take advantage of historic lows and refinance into a new loan.

For more insights about mortgages and refinancing see these AOL Real Estate guides:

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