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3 Things You Should Consider Before You Refinance

TLDR

What You Need To Know

  • Refinancing can cost between 3% – 6% of your loan amount so weigh the costs against the potential savings to see if it makes sense to refinance
  • You may qualify for favorable mortgage terms with a credit score higher than 640 and a debt-to-income (DTI) ratio lower than 36%
  • To avoid costly terms and mortgage insurance, aim for at least 20% home equity or a loan-to-value (LTV) ratio of 80% or lower before refinancing

Contents

Hey, homeowners, you’ve survived the mortgage process at least once already. And, honestly, there was no better training ground to prepare you to refinance your current home loan.

You may be wondering when it would make sense to refinance your mortgage. And if you’re like so many of us, you’re probably coming up with more questions than answers.

It wouldn’t surprise us if you already knew that low interest rates, higher home values and opting to make higher monthly mortgage payments over a shorter loan term are all good reasons to refinance.

But you’re not here to learn what you already know.

There are other key factors you’ll need to consider to help you make an informed decision on the timing of your refinance. We can help you assess your situation to determine if refinancing is the right choice and if you’re doing it at the right time.

Should I Refinance My Mortgage?

There are a lot of benefits that can come from refinancing your mortgage, including helping you reach other money and lifestyle goals sooner. Here are some other reasons to consider a refi:

  • You want to change your loan term: If you need to lower your monthly mortgage payment, you can lengthen your mortgage term. Shortening your term can help you own your home sooner.
  • You want a lower mortgage rate: Refinancing to a lower interest rate will lower your monthly mortgage payments and the total amount you’ll pay in interest over the loan’s lifespan.
  • You want to tap into equity or consolidate debt: A cash-out refinance taps into the equity in your home. You can use the money to save for retirement, for home improvement projects or to pay off debt.
  • You want to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage: Switching from an ARM to a fixed-rate mortgage keeps your interest rate locked in for the life of the loan. You can switch from a fixed mortgage to an ARM to take advantage of falling interest rates, but that can be risky because rates could go back up.
  • You want to get rid of mortgage insurance: Some Federal Housing Administration (FHA) loans and conventional loans have high mortgage insurance. Switching to a different type of home loan might help you save money by getting rid of mortgage insurance.

Most refi applications take 30 – 45 days to close. The amount of time can vary, so be aware of how long it may take to refinance if you need to time it to a specific event.

If you were wondering how many times you can refinance your mortgage, we’re here to tell you that there is no hard-and-fast limit. But take into consideration that there may be waiting periods and other requirements that must be met before you can get another refinance approved – like having enough money on hand for closing costs, meeting credit qualifications or waiting to refinance so you don’t trigger any prepayment penalties.

Speaking of costs and credit qualifications, let’s take a look at three key items you should consider before refinancing your mortgage.

1. Know the Cost of Refinancing

When you bought your home, you probably paid closing or settlement costs. It’ll be no different when you refinance.

We’ve broken down the costs and expenses associated with refinancing. The fees include:

  • Home appraisal fees ($300 – $500)
  • Origination fees (up to 1.5% of a loan’s value)
  • Application fees (up to $500)
  • Title search fees and other related title services (upwards of $1,000)
  • Attorney closing fees (depends on your state and local rates)
  • Inspection fees ($200 – $600)

These costs can range from 3% – 6% of the mortgage loan’s value. The origination fee alone can equal up to 1.5% of the loan amount. And if the equity in your home is less than 20%, you may have to pay for mortgage insurance.

It may not make sense to refinance your mortgage if you plan on selling in a few years. Generally, the savings you get from refinancing aren’t instant; they’re earned over time. If, after paying your closing costs, you turned right around and sold your home, you may not get to see those savings.

If you plan on selling quickly, refinancing with a no-closing-cost mortgage might help with upfront costs. With a no-closing-cost mortgage, your closing costs usually get rolled into your mortgage balance or made up for in the interest rate. You’ll either end up with a higher loan principal or a higher interest rate to cover the closing costs.

Other important considerations to take into account:

  • Lower monthly payments or a shorter loan term: The length of time it takes to repay a loan will affect how much you pay out – or save – in interest. A loan’s terms will also factor into how much income you’ll need to comfortably make your monthly mortgage payments.
  • Pay for mortgage points or get a cash-in mortgage to lower your refinance rate: In both cases, you pay a lump sum upfront in exchange for a lower interest rate. A mortgage point typically costs 1% of your mortgage amount and lowers your interest rate by 0.25%.
  • Prepayment penalties on the existing mortgage: Check your mortgage contract or your monthly billing statement for a prepayment clause. See if you’ll be charged a fee for paying off all or part of your mortgage early. Because a refinance pays off an existing mortgage, it could trigger penalties.
  • If you itemize your taxes, you’ll have less mortgage interest to deduct: It may affect how much you get back, or how much you pay back when you file your taxes.

Is refinancing worth it?

To know if refinancing will save you money, beyond assessing your finances and figuring out your closing costs, it would be a good idea to figure out your new mortgage payment.

Of course, you’re free to use our mortgage calculator to crunch the numbers. Get estimated monthly mortgage payments and learn how to pay your mortgage off over time. See your potential monthly savings and decide if it makes sense to refinance.

2. Know Your FICO® Score and DTI

When you refinance, you swap out your current mortgage with a new loan. And that new loan will come with a new credit check.

To qualify, you’ll usually need a credit score of 640 or higher. Generally, the better your credit, the better the terms you’ll be offered.

If you’ve maintained your credit score or, better yet, it’s gone up since you got your first mortgage, it can be a good sign that it’s time to refinance. A qualifying credit score signals to a lender that you’ve managed your debt well and you reliably make your payments.

Because the lender will perform a “hard check” on your credit history, you will experience a dip in your credit score – but it’s temporary. A drop in your score can also be caused by:

  • Multiple hard credit pulls
  • Submitting multiple mortgage applications (FICO® recommends submitting all mortgage applications within 30 – 45 days to lessen the impact on your score)[1]
  • Paying off your current mortgage (closing a credit account in good standing may lessen the impact on your score)

For conventional loans, lenders also look at your debt-to-income (DTI) ratio. That’s a calculation of your total monthly debt as a percentage of your gross income. Ideally, you need a DTI of no more than 36%. Even if your DTI is higher, you may still qualify with a higher FICO® Score.

3. Know Your LTV To Check Your Equity

Your loan-to-value (LTV) ratio is another key measure in the refinancing process. It looks at the relationship between your current mortgage amount and the value of the property.

LTV is one of the ways lenders calculate the level of risk they’ll take on if they approve a mortgage – and it helps you figure out your home equity.

The more money you put into paying off your current mortgage and/or the higher your home appraisal value, the more home equity you have. The more equity you have in a home, the smaller the loan you’ll have to apply for. A smaller loan signals to a lender that you are less likely to default on your new mortgage.

In some cases, when you have more than one loan on your home, your combined loan-to-value (CLTV) ratio is used. It’s calculated in the same manner as LTV, only with your CLTV, it’s the sum of your primary mortgage balance plus any other loans on the property divided by the current value of the home.

Calculating your LTV and equity: Risky business

Let’s say that your mortgage balance is $150,000 and your home appraisal value comes in at $200,000.

To figure out your LTV, divide the amount you owe by the home appraisal value:

LTV ratio = $150,000 / $200,000 = 0.75, or an LTV of 75%.

Once you’ve calculated your LTV, you’ll know how much equity you have in your home. Equity is the difference between your home’s fair market value (which should be the same as its appraised value) and your current mortgage balance. To calculate your equity, take that difference and divide it by your home’s value.

You can also figure out your home equity by subtracting your LTV from 100%. Using our example above, if your LTV is 75%, you’d have 25% equity in your home.

Let’s look at the numbers:

  • An LTV of 80% or lower means you’re more likely to be approved, you’ll get a lower interest rate and you’ll avoid paying fees for mortgage insurance, private mortgage insurance (PMI) or mortgage insurance premiums (MIPs).
  • An LTV higher than 80% doesn’t necessarily mean that you won’t be approved, but you may end up with a higher interest rate and paying for mortgage insurance, PMI or MIP.
  • Because CLTV is a more comprehensive picture of your financial situation than LTV, lenders may be more willing to approve a mortgage with a CLTV higher than 80% if you also have a high credit score.

Keep in mind that different types of mortgage loans – like Federal Housing Administration (FHA) loans, Department of Veterans Affairs (VA) loans, Fannie Mae loans, etc. – may have different LTV requirements, and 80% isn’t a hard-and-fast rule for each loan. Ask your lender or mortgage broker about the LTV rules for each mortgage refinance you’re interested in.

Bonus Tip: Recognize When It’s a Good Time To Refinance

There is no “refinance season.” Lenders are willing to work with qualified buyers at any time of the year.

But keep in mind that lenders are also busier when rates drop. Lenders may be more willing to consider your application when they have more time.

If rates are low, you may be able to get a better refinance rate than the mortgage rate you currently have. Even half a percentage point difference in interest can mean thousands of dollars in savings over the life of the mortgage.

One of the most common reasons why homeowners refinance is to lower their interest rates. But interest rates shouldn’t be the sole factor that determines whether you refinance or not.

It’s a good time to refinance when your credit score is 640 or higher, you have at least 20% equity in your home and current interest rates provide advantages – like lower monthly payments, a shorter repayment term or access to cash through your equity.

Setting Yourself Up For Refinancing Success

If mortgage refinancing is your goal, take strategic steps now to qualify for favorable mortgage refinance terms. Monitor your credit score and pay off credit card debt, medical bills, student or personal loans and other debts to keep your debt-to-income (DTI) ratio low.

Not enough equity in your home? Make extra mortgage payments to lower your current loan balance and build equity faster. Just be cautious of any prepayment penalties that may come with making extra payments. If you can, consider making strategic home improvements that raise your home’s appraised value and could tweak your LTV.

  1. myFICO®. “Credit Checks: What are credit inquiries and how do they affect your FICO® Score?” Retrieved December 2021 from https://www.myfico.com/credit-education/credit-reports/credit-checks-and-inquiries

ICYMI

In Case You Missed It

  1. Refinancing may be worth it if you want to get a lower interest rate, tap into equity, consolidate debt or get a different loan type or term

  2. Using a mortgage calculator can help you figure out if refinancing will put you in a better or worse financial position

  3. Set yourself up for refinancing success by practicing good financial habits, like paying off debt and monitoring your credit score

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