If you took on an adjustable-rate mortgage (ARM) a few years ago, you might have done so with the expectation that you would refinance once the interest rate started increasing. Now, you’re probably wondering whether refinancing is the best option.

Refinance Qualifications

Refinancing your mortgage loan generally only makes sense when you can get a better interest rate than your current one or when you can switch from an adjustable interest rate to a fixed rate.

These days, it’s harder to get a great mortgage interest rate. To get the best rates, you need a FICO above 720, at least 20% equity in your home (that hasn’t been used to secure a second mortgage or home equity loan), and two years of steady income. Without all three of those things, you may not get the best rate or you may be denied a refinance all together.

You typically need to have no late payments within the previous year before you refinance. Check your credit report before you apply for the refinance to be sure your credit report is free from late payments. If you find erroneous late payments, you can dispute them with the credit bureau. Showing proof that your payment was made on time will help make sure your credit report is corrected.

Making Home Affordable

The government’s Home Affordable Refinance Program has less stringent requirements – you can refinance a mortgage that’s up to 125% of the home value as long as Fannie Mae or Freddie Mac backs the mortgage. You also need to have enough income to afford the new mortgage payments.

Is the New Interest Rate Better?

Remember, when you refinance, you’ll still have to pay closing costs that will increase the cost of your loan. Your interest rate on the new loan needs to be low enough that your interest savings will exceed the closing costs. Bankrate.com says that your new, refinanced interest rate needs to be at least 2% lower than your current rate for you to see any savings. If your refinanced interest rate fails the 2% test, postpone your refinance until you qualify for a better rate.

If you’re wondering whether a refinance is worth it, you can use a mortgage loan refinance calculator to figure out whether you’ll actually save money with the new loan.

Prepayment Penalties

If you meet all the qualifications for a better refinance, you then must make sure it won’t hurt you to pay off your whole mortgage. Some mortgage contracts include a penalty for paying off your entire mortgage. The prepayment penalty is typically a percentage of the balance you pay off or six months of interest.

Check your loan documents to find out if you have a prepayment penalty. If your mortgage loan does have this penalty, it may only apply during the first few years of your loan. If that’s the case, you might wait until the prepayment penalty no longer applies to refinance.

Refinance Terms

You can refinance your mortgage for a shorter term (fewer years), which will allow you to pay off your mortgage sooner. You can also reduce your mortgage repayment period by simply sending additional payment every month.

If you lengthen the term of your loan (more years), you’ll lower your monthly payment, but you’ll be paying on the mortgage longer and may pay more interest in the long run.

Mortgage refinance generally isn’t a good idea when you’ve had your mortgage for a long time or when you plan to move soon.