Refinancing your home loan can be a great way to save on interest — and in some cases, it may even make your home loan more affordable. But refinancing your mortgage isn’t the best move for everyone. If you’re considering refinancing, you’ll want to find an affordable and reliable real estate agent to help you find the best refinance options available.
Here are 13 things you should know before deciding to refinance your mortgage.
1. Understand what ‘refinancing’ means
When you refinance your home loan, you’re essentially taking out a new mortgage and using it to pay off your old home loan. Typically you only want to do this if you can lock in a lower rate, which can help reduce the amount of interest you’ll pay over time.
2. Be aware of other reasons to refinance
While saving money is the primary goal when refinancing, there may be some other reasons why you might want to consider this option. For instance, if you’re struggling to make your monthly mortgage payments, refinancing could help lower your monthly payments by stretching out your loan term. This may cause you to pay more interest overall, but you will have more money to spend on other things on a monthly basis.
However, you may decide to refinance to pay off your mortgage sooner, converting a 30-year mortgage into a 10-year or 15-year mortgage. This will raise your monthly payments but can save you tremendously in interest payments.
3. Know your current home loan details
Before you can decide if refinancing makes sense for you, you’ll want to make sure you know your current home loan’s rate and how far into your loan term you are. This will come in handy when you start the research phase.
4. Determine if you have a fixed or adjustable rate mortgage
In addition to reviewing your current rate and loan term, it’s also a good idea to know if you have a fixed-rate or adjustable-rate mortgage. A fixed-rate mortgage means you pay the same interest rate throughout the lifetime of the loan. If current rates drop, it may make sense to lower a fixed-rate loan.
An adjustable-rate mortgage typically locks in a mortgage rate for a period of time before the rate fluctuates with the market. So, if you’re nearing the end of your fixed-rate period, it could make sense to refinance to a fixed-rate mortgage — depending on where the market is headed.
5. Review current market rates
It’s a good idea to familiarize yourself with the current housing market and mortgage interest rates before refinancing. For instance, if rates are expected to drop later in the year, it might make sense to wait to refinance until you can lock in an even lower rate. You also want to make sure rates are lower than your current mortgage — otherwise, it may not be worth considering refinancing at this time.
6. Make sure you have at least 20% equity in your home
You’ll also want to be sure you qualify to refinance your home. Most lenders require that you have at least 20% equity in your home before you can refinance. If you paid 20% down when you bought your home, you probably meet this equity requirement. But if you put down less of a down payment, you’ll want to do some math to see if you qualify to refinance.
7. Check your credit score
Next, you’ll want to review your financial profiles to make sure you’re likely to get approved for a low rate if you decide to refinance. Check your credit score (preferably from all three major credit bureaus) to make sure there are no errors. If you spot a mistake, you can dispute the discrepancy to try to remove it from your credit profile before applying for refinancing.
If your credit score is lower than you’d like, consider waiting to refinance until you can take steps to improve your credit and boost your FICO score.
8. Figure out your debt-to-income ratio
Another factor lenders look at when approving you for a new loan, like a refinance, is your debt-to-income ratio, or DTI. This tells lenders how much debt you pay each month, versus how much money is coming in. So, if you pay $2,000 in debt each month, and earn $5,000, your DTI would be 40% (Monthly debt divided by monthly income = DTI).
Typically, you want to aim for a DTI that’s 43% or below to get approved. But if you can take steps to pay down your debt and lower your DTI even more before applying, you’re more likely to get approved — and possibly at a lower rate.
9. Consider working with a real estate agent or broker
You don’t need to partner with a real estate agent or a real estate broker when refinancing — but it can be helpful. If your credit is excellent, you may be able to find competitive rates on your own. But a trustworthy real estate agent can help you navigate this process and potentially secure better home loan options than you would on your own.
10. Plan for closing costs
Since a refinance loan is a new home loan, there are some additional fees you’ll need to keep in mind, like closing costs. Although you typically won’t need to save for a down payment (as long as you have enough home equity), you will need to pay closing costs.
Working with an experienced real estate agent can help you to better plan for these expenses and keep your costs low.
11. Think about your plans for the home
Even if you have enough equity and can save money by refinancing, it may not be worthwhile if you’re planning to move in a couple of years. In this case, it may be better to keep the new home loan and sell your house when you’re ready to move. Then you can focus on buying a new home in a few years, rather than worrying about refinancing.
Since closing costs and other fees are added to your refinance costs, it can be more expensive to refinance in the short term. The savings generally add up over the lifetime of the new loan. You can calculate your break-even point (the point where refinancing will begin to save you money) by dividing the amount you’ll save each month from your closing costs. This number will tell you how many months it will take to start realizing savings.
For example, if you’ll save $150 in mortgage costs each month and your closing costs are $4,000, it will take you almost 27 months (just over two years) to realize savings.
12. Make sure you review your mortgage insurance rules
If you’re refinancing, you may be able to drop your mortgage insurance, depending on the type of home loan you have. While you cannot eliminate mortgage insurance with an FHA loan (unless refinancing into another loan type), typically if you paid more than 20% of the home loan or have more than 20% in equity, you can eliminate your mortgage insurance — saving you even more money each month.
You can check with your real estate agent if you have any questions about your current mortgage insurance.
13. Shop around for different lender quotes
While it’s a good idea to review different lender offers online, ultimately you’ll want to get prequalified or preapproved to view the rates you’re likely to be approved for and compare offers across multiple lenders.
If you’re not sure where to start, talk to your real estate agent about the best refinancing lenders in your area.