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3 Things You Should Consider Before You Refinance

tl;dr

What You Need To Know

  • Good credit scores and less debt can help you qualify for a new mortgage loan with desirable terms
  • More home equity means advantageous rates and terms
  • Weigh refinancing costs against the value of a lower interest rate or a shorter term

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If you’re a homeowner, congrats! You survived the mortgage process once already, giving you a good baseline for what to expect when it comes to refinancing your home loan.

Maybe interest rates are low and home values are up. So, it’s no surprise that you’re asking yourself if you should refinance your mortgage. Makes sense to get a new loan with a lower interest rate rather than stick with your current mortgage, right?

Or maybe you’re in a better financial spot than when you secured your original mortgage, and now you’re ready to take on a higher monthly payment with a shorter loan term, saving you on interest payments in the long run.

There are three other key factors to consider to help you make an informed decision on whether the timing is right for you. Learn how to assess your situation and see if refinancing is the right choice.

Should I Refinance My House? Things To Consider

Just like when you were preparing to buy your home, you have to think about your current financial situation and credit score before you decide if you should refinance your existing mortgage.

You’ll also want to think about how much equity you have in your home, as this will impact how much your new loan will be.

These factors will give you an idea of whether you can refinance and what kind of interest rate and refinancing terms you may be able to negotiate.

Don’t forget about the associated costs of refinancing. These details provide an accurate picture of the entire cost of refinancing and whether it’ll put you in a better or worse financial position.

Be Aware of All the Costs of Refinancing: Closing Costs and Fees

When you bought your home, you probably paid closing or settlement costs. You’ll do the same thing when you refinance.

Consider all the costs when deciding if you should refinance. There are lots of fees, including:

  • Home appraisal costs
  • Origination fees
  • Application costs
  • Title search and other related services

These costs can range from 2% – 6% of the loan’s value. The origination fee alone can equal up to 1.5% of the loan amount. If the lender categorizes you as a high-risk borrower, you may have to pay for private mortgage insurance as well.

Other important considerations include:

  • Whether you’re looking for lower monthly payments or a shorter loan term
  • If it makes sense to pay for points or get a cash-in mortgage for a lower interest rate
  • If you itemize your taxes, don’t forget that you’ll have less mortgage interest to deduct

Look at the big picture. Calculate how long it will take to recover all your costs. Then evaluate whether refinancing will benefit you.

See If Your Credit Is Good Enough: Know Your FICO® Score and DTI

Like the mortgage process, refinancing means taking out a new loan. And that means a lender will review your credit to see how risky a borrower you are.

To qualify, you’ll want a credit score of 640 or higher because your score also affects your interest rate and repayment length. The better your credit, the better the financing terms.

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

Check That You Have Enough Equity in Your Home: Know Your LTV

Your loan-to-value (LTV) ratio is another key measure in the refinancing process.

Loan-to-value looks at the relationship between how much money you take out to buy a home versus 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. You’ll look like a better bet to lenders with a low LTV ratio.

The more money you put into the house, the more equity you have in it. This signals to a lender that you are less likely to default on paying the mortgage. The lower your LTV, the more likely you are to secure better loan terms, like avoiding private mortgage insurance and scoring a lower annual percentage rate (APR).

Calculating your LTV ratio: Risky business

Let’s say that you owe $150,000 on your house and the home appraisal value comes in at $200,000.

To figure out your LTV ratio, divide the amount owed by the home appraisal value:

LTV ratio: $150,000 (amount owed) ÷ $200,000 (home appraisal value) = 75%

A percentage of 80% or lower will help you avoid paying fees for private mortgage insurance.

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

There is no “refinance season.” Loan officers are willing to work with qualified buyers at any time of the year. If rates are low, you may be able to get a better refinancing rate.

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.

But remember, interest rates shouldn’t be the sole factor that determines whether you refinance.

It’s a good time to refinance when your credit score is up, 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.

Use Your Smarts To Refinance Your Home

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

Not enough equity in your home? Make extra payments on the principal to lower your current loan balance and build equity faster. Consider making strategic home improvements that raise your home’s appraised value and could tweak your LTV ratio. Overall, good financial habits will make all the difference.

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In Case You Missed It

Take-aways

  1. With a good credit score and a debt-to-income ratio lower than 36%, you can qualify for cost-effective mortgage refinancing terms
  2. Aim for at least 20% equity in your home before refinancing to avoid costly terms and mortgage insurance payments
  3. Refinancing costs can average between 2% and 6% of the loan amount, so weigh the costs against the savings

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