Refinancing your mortgage can be a smart financial decision. It can help you save money or achieve personal finance goals. Since your home is the largest investment you’ll likely own, you can use it to your advantage to achieve other financial goals if you plan to stay in the home for a while.
Before you refinance your mortgage, consider these factors to ensure you understand the loan and how it affects your personal finances.
What is Mortgage Refinancing?
When you refinance your mortgage, you borrow a new mortgage. It can be with the same lender or a new lender. There aren’t any rules regarding who you must refinance your mortgage with, so choose the lender that offers you the best deal.
When you refinance, you restart your loan’s term and get a new interest rate. You’ll sign new closing documents, and the new mortgage will get recorded with the county. The new lender takes the first lien position on your home, and you make payments to the new lender.
How can Refinancing your Mortgage Help You?
Mortgage refinancing can help homeowners in several ways. How it helps you depends on your financial goals. Here are a few examples of how it can help.
- You can lower your interest rate and save money monthly and over the loan’s term
- You can tap into your home’s equity, using the funds for other purposes, such as home renovations or consolidating debt
- You can change your loan’s term, whether shorter or longer, to achieve your personal financial goals
Talking with a loan officer can help determine if you can leverage your home’s equity or if there is a way to save money on your mortgage. Whether you want to pay your loan faster or need a smaller mortgage payment, refinancing a home may help.
Consider these Factors Before Refinancing your Mortgage
Refinancing has plenty of advantages, but it’s not for everyone. Understanding the factors you should consider is important as you decide how to proceed.
Is Mortgage Refinancing the Right Choice?
Not everyone benefits from mortgage refinancing. First, ask yourself the following questions:
- How long will I be in the home? If you aren’t staying in the house long, paying for a refinance doesn’t make sense.
- What am I trying to accomplish? Think about why you want to refinance. Are you having trouble making your payments? If you’ve hurt your credit, you may need a loan modification, not a refinance. But if it’s another goal, it could be worth it.
- Is my home worth enough? If you’re trying to eliminate Private Mortgage Insurance or FHA mortgage insurance, make sure your home is worth at least enough that your loan-to-value ratio is less than 80%.
Can you Afford the Cost of Refinancing?
All mortgage loans cost money, and home mortgage refinancing isn’t different. You’ll pay closing costs like you did when you bought the home. The fees may be lower, but you will likely still pay a few thousand dollars to close the loan.
Consider your break-even point while figuring out if you can afford the cost of refinancing your mortgage.
This pertains to a refinance when trying to save money on your loan. Because refinancing costs money, you should ensure the savings outweigh the costs. To determine your break-even point, do the following:
Total closing costs/Monthly savings = Months to break-even
A good break-even point is typically 24 months or less, but you know your personal finance situation. If you can’t cover the costs in a couple of years, it’s likely not worth it.
Is your Credit Score High Enough?
You should have good credit when you refinance your mortgage. It will get you better rates and terms.
Pull your free reports here if you don’t know your credit history. Look for any negative information, such as late payments, credit lines with more than 30% of the credit line outstanding, or collection accounts.
Your credit card companies or banks may also offer access to your credit score, as most financial institutions offer free credit score access to your account.
Most lenders look for a credit score of 660 or higher to refinance your mortgage.
Do you Have a Low Debt-to-Income Ratio?
You’ll need a low debt-to-income ratio for a lower mortgage payment. This is the comparison of your monthly debts to your income before taxes. Ideally, your DTI should be less than 43% for the best rates and terms.
If you’re doing a cash-out refinance and using the funds to pay off your debt, you may have a higher DTI now, but it will drop when the loan disburses. This is because lenders may require that they pay your creditors off with the proceeds to approve you for the loan.
Understand the Types of Refinancing
Before refinancing a home, make sure you understand the types of refinancing, including:
- Rate/term refinance – You refinance strictly to lower your interest rate and change your loan’s term. Typically, this is to get a lower payment or pay the loan off faster.
- Cash-out refinance – If you have home equity, you can use it for other purposes rather than leaving it tied up in your home. A cash-out refinance is a loan for a larger amount, but you receive the difference between the new and current loan amount as cash to use how you want.
Closing Summary
If you decide to refinance your mortgage, determine why you want to refinance. For example, are you trying to get cash or change your loan’s rate and terms?
Perfect your credit score, lower your debt-to-income ratio, and look for the loan with the best terms. A refinance can help you pay off your loan faster and reach your financial goals.
Talk with a licensed loan officer to discuss your options and explore what will help you and your family make the most of the investment in your home.
