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When it’s Worth it to Refinance Your Mortgage – and When it’s Not

In 2018, mortgage rates are expected to rise to their highest point in seven years, an average of 4.875 percent. In contrast, the average mortgage rate in 2016 was closer to 3.5 percent.

According to Sam Khater, the chief economist for lender Freddie Mac, rising mortgage rates might curb demand for new homeowners — making it harder for those who wish to sell.

"Homebuyer demand has remained positive and shaken off the higher rate environment so far this year," Khater told CNBC.

"However, after years of very low mortgage rates, the symbolic risk of a 5 percent mortgage, on top of higher gas prices, may cause a slowdown in homebuyer demand, particularly in western states and exurbs that are affected more by gas prices than the typical consumer," he added.

Rate hikes may cause bumps in the road for homeowners looking to refinance, too. Here’s what you need to know about when it’s worth it to refinance your mortgage before interest rates creep up, and when it makes sense to hold steady.

When Refinancing Your Mortgage Might Be a Good Idea

1. You can lock in a lower interest rate

The primary reason homeowners decide to refinance their mortgage — essentially paying off their old loan with the money provided by a new one — is to lock in a lower interest rate.

But this move only makes sound financial sense if the conditions are right, cautions finance reporter Kerry Close. When you consider banking and attorney fees, refinancing your mortgage costs a good deal of money — as much as 2% of the loan's value.

"As a result," Close writes at TIME, "it generally doesn't make sense to refinance unless you can lower your rate by at least half a percentage point and plan to stay in your house for at least five more years."

That’s how long it can take to break even from refinancing, though you can generally get a better sense of your break-even point by doing a bit of math. For more information on how to calculate your break-even point, read this guide from Forbes.

2. You can shorten the loan term

Most mortgages offer a fixed rate at a 30-year loan term. When homeowners opt to refinance their mortgage, it may be because they’ve found a lower interest rate that would allow them to shorten the loan term — paying off their mortgage sooner.

The trade-off here? You may wind up paying more per month — but you would pay less overall. It’s a good option for those who can afford to make bigger monthly payments.

To learn more about what a shorter loan term might do to your mortgage, check out this helpful Q&A with finance expert Josh Garskof at TIME.

3. You can convert to a fixed-rate APR

Mortgages come in all shapes and sizes, but the two most common interest rates are fixed-rate and adjustable-rate. While a fixed-rate mortgage locks you in to a single interest rate over the period of the loan, an adjustable rate will fluctuate after a specified period.

Now that the economy has largely recovered from the 2008 recession, interest rates are on the move — which might make anyone with an adjustable rate mortgage nervous.

Converting from an adjustable-rate mortgage to a fixed-rate mortgage might be worth the expense, if you can calculate your break-even point and decide when you'll start seeing savings with a new fixed-rate APR.

4. You need flexibility to finance a large purchase

Most homeowners expect that their home will grow in value over time — that is, gain equity.

A “cash-out refinance” gives homeowners the ability to take out a loan against the current value of their house, giving them flexibility to finance a large purchase.

Say you’ve been making payments on a mortgage for a number of years and have $100,000 left until your home is paid off. In the meanwhile, your home has increased in value to $300,000. If you applied for a “cash-out refinance,” you could ask for a $150,000 loan — $100,000 to cover your mortgage and $50,000 in a cash payment.

Essentially, the cash-out refinance allows you to leverage the value of your home for a cash loan you can use for home improvements or to consolidate other forms of debt.

But this option can be dangerous for some, cautions financial expert Janna Herron. You still have to have a plan to pay back the cash loan over time, and the value of your house could still go down.

“Taking out equity puts you at greater risk of owing more than your home is worth when housing values go down,” explains Herron at Bankrate.com. “Several Federal Reserve studies have found that default rates on cash-out refis are higher than those on regular refinances.”

While a cash-out refinance can help you put your hands on more money faster, it comes with plenty of strings.

When You Should Stick with Your Current Mortgage

1. You're planning to move

Considering a move within the next five years? Then it might not make sense to refinance the terms of your loan, says financial reporter Ashley Eneriz.

“Selling too soon after refinancing means you won’t live in your home long enough to capture the savings benefits of lower rates,” explains Eneriz at TIME. “Plus, you’ll still owe any fees associated with the new loan.”

It’s better just to keep making payments until it’s time to sell.

2. Your credit score has taken a hit

Good credit makes a huge difference in the interest rate a lender will offer a potential homeowner for a mortgage.

According to The Washington Post, homeowners with credit rates of 650 or lower are routinely offered interest rates of between 3.75 and 4.5 percent, while a higher credit score nets interest rates closer to 3.6 percent. Raising your credit score by as little as 25 points can make a huge difference in the rate you’re offered.

Worried about your credit score but still need to refinance? Make sure to get a free credit report from AnnualCreditReport.com to see where you stand, then follow these tips from NerdWallet to improve your credit before you apply.

3. The math doesn’t add up

Some homeowners can be persuaded to jump at the prospect of a lower interest rate — but this can work against them in the long run, especially if they’ve already made quite a bit of progress on their current mortgage.

Even if you manage to secure a lower interest rate, pay careful attention to the term of your loan — has it extended to another 30 years? If so, you could wind up paying more! Your best bet is to simply do the math, and to figure out your break-even point.

“The simple calculation for your break-even point is calculating the fees and the closing costs and dividing those by the savings,” Jared Maxwell, the vice president of Embrace Home Loans, explained to NerdWallet.

Essentially, your break-even point can help put your decision to refinance into perspective. Are you planning to stay in the home long enough to see the financial benefits of a lower interest rate or a shorter loan term? If not, it doesn’t make sense to take the leap.

If you’re thinking of refinancing your mortgage to lower your monthly payments or get access to more cash, it pays to be smart. Work closely with a financial advisor when making any major decisions regarding your home — the consequences can be lasting.

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