Even if interest rates are lower, refinancing may not always be the best path forward. ( iStock )
Refinancing your home mortgage could potentially reduce your interest rate and monthly payments or give you access to some of the equity in your home. But that doesn’t necessarily mean it’ll save you money or it’s a good decision.
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If you’re thinking about refinancing your mortgage loan, here are 10 things to keep in mind before you pull the trigger.
1. Your reason for refinancing
Refinancing a home loan can be expensive, so it’s crucial to know why you want to do it. For example, maybe you want a lower interest rate or monthly payment, or you want to do a cash-out refinance to pay off high-interest debt or make some home improvements.
Whatever your reason, make sure it’s worth the costs and work associated with refinancing your existing mortgage. Online marketplace Credible allows you to find out what rates you qualify for right now. Check it out.
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2. The current mortgage rates
It generally doesn’t make sense to refinance your home loan unless they’re lower than what you’re currently paying. Before you start submitting applications, check the current mortgage rates to see how they compare with your existing mortgage.
Also, keep in mind that just because mortgage rates are lower now, that doesn’t mean they’ll stay that way. If reducing your interest rate and monthly payment are your top priorities, start applying sooner rather than later.
You can visit Credible to compare mortgage rates from multiple lenders in one place.
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3. The type of rates advertised
As you compare your current loan with market rates, make sure you’re comparing apples to apples. For example, adjustable-rate mortgages typically start with lower interest rates than fixed-rate mortgages. However, after their initial fixed period, they can fluctuate based on the current market rates.
So if you have a loan with a fixed rate, make sure you’re comparing it with new fixed-rate loans, unless switching to an adjustable rate is your goal. In general, though, it’s more common to switch from an adjustable-rate to a fixed rate for more certainty.
4. Your credit score
While average mortgage rates can give you an idea of whether or not you can save, your actual rate on a refinance loan will depend largely on your credit history, existing debt, and income.
Check your credit score to see where you stand. If it’s lower than it was when you first bought the home, you may need to take steps to improve your score before you apply. Credible's online tools can help you compare lenders without any impact on your credit score.
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5. Your debt-to-income ratio
Your debt-to-income ratio—how much of your monthly gross income goes toward debt payments—is a major factor in determining your eligibility for a mortgage loan. If you’ve taken on more debt since you obtained your existing mortgage loan, it could make it difficult to refinance.
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6. Your home’s equity
If you’re hoping to tap some of your home equity with a cash-out refinance, the home value is an important indicator of whether you’ll qualify and how much you can take out.
In general, lenders will allow you to borrow up to 80 percent of your home value. So if the home is worth $300,000, the maximum new loan is $240,000. If your current loan is for $200,000, you could potentially get up to $40,000 in cash with a cash-out refinance. But if your loan is at $240,000 or above, you likely won’t qualify.
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7. Closing costs
Closing costs on a mortgage refinance can range from 2 percent to 6 percent of the loan amount, which can run in the thousands of dollars. If you don’t have enough cash to pay those closing costs out-of-pocket, you may be able to roll them into the new loan—assuming the loan still meets the requirement of being 80 percent or less of the home value.
However, rolling them into the refinance means you’ll be paying interest on them over the life of your new loan.
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8. Break-even point
If you’re refinancing to save on your monthly payments, you’ll need to divide the monthly savings by the amount of the closing costs to determine how long it’ll take you to break even on those upfront expenses. If you’re planning to move before that time, it may not make sense.
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For example, let’s say a refinance could save you $100 per month, but the closing costs are $5,000. In this scenario, it would take you 50 months to break even. If you’re planning to stay in the house longer than that, it makes sense. But if not, you may want to stick with your existing mortgage.
Consider using an online refinance calculator to help you determine whether refinancing makes financial sense.
9. Mortgage insurance
If you put down less than 20 percent when you first bought your home, you may be paying private mortgage insurance (PMI). With some government-backed loans, you may be paying some other form of mortgage insurance.
Depending on how much your home value has increased and how much of your current loan you’ve paid down, though, refinancing could help you eliminate mortgage insurance from your monthly payments, increasing your savings.
10. Your new mortgage term
Refinancing not only allows you to get a new interest rate but also a new repayment term. You can generally choose between a 10-year, 15-year or 30-year mortgage. While a shorter term will ensure you’ll be debt-free sooner, you’ll want to make sure you have enough room in your budget for a higher monthly payment.
And while resetting to a 30-year mortgage again can reduce your monthly payment, it will also result in more interest over the life of the new loan.
Visit an online marketplace like Credible to view refinance rates and loan options. You can get prequalified without impacting your credit score.
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The bottom line
Refinancing your mortgage isn’t always a good idea. Take your time to understand your situation, research your options and run the numbers to make sure it’s the right time and the best path forward.
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