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Refinance Mortgage — or Not?

Consider not only the advertised interest rate, but also closing costs and credit score

Q. I'm tempted by record-low mortgage rates and the chance to reduce my monthly payment. How can I figure out whether refinancing makes sense?

A. If you can get a new rate that's at least a full percentage point lower than your current rate (or, ideally, closer to two points), refinancing can make sense and save significant dollars.

See also: Refinancing options after 50.

But before you proceed, consider these other questions:

  • What will you pay in fees? You'll typically spend the equivalent of 2 to 6 percent of your loan's principal on fees and closing costs, says the Federal Reserve. These costs will vary with your lender and state. Visit the Fed's online guide to get estimates. Be aware, too, of potential prepayment penalties.
  • How long have you been paying your current mortgage? If you're at least 10 years into a 30-year mortgage, refinancing to another 30-year loan might lower your monthly payment, but it will significantly increase your long-term costs — you'll be paying interest for many additional years.

The better choice may be to refinance to a loan that matches the time remaining on your present one or shortens it. An amortization chart — available from your current lender or its website — can help you determine the actual costs and accrued equity.

  • How long do you expect to live in the refinanced home? If you're planning to sell in the next few years, the savings from lower monthly payments may not exceed the costs of refinancing.
  • What's your home really worth? One of the biggest mistakes that you can make when applying for a new loan, reports the website LendingTree, is overestimating your home's value in a time of fallen prices. When the lender's formal offer comes in, based on an up-to-date appraisal, the terms may be worse than what you'd planned on.

And to get the best rates, the borrowed amount should be less than 80 percent of your home's value, as determined by that appraisal.

  • How high is your credit score? Those advertised low rates often apply only to people with high credit scores, typically 760 or better. If you've got a FICO score in the 680-700 range, you can expect to pay about 0.5 percentage point more. If you're in the 620 range, you'll likely pay 1.5 percentage points higher.

To help determine your true bottom line savings — if any — use this AARP refinancing calculator, or others you can find online.

You may also like: Retire without a mortgage. >>

Sid Kirchheimer writes about consumer and health issues.

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