Simply put, refinancing a loan is the process of paying off your current loan with a new loan plan, which has a lower interest rate. The average homeowner will keep any given mortgage seven years or less before moving or refinancing. In a declining interest rate environment, that holding period for the loan would decrease even more.
Before you opt to refinance, do your financial research. A little due diligence goes a long way to big savings. There are many factors to consider before you refinance.
Negotiating the best borrowing rate starts with a strong credit score. You can achieve this by paying your bills on time, cutting back on borrowing and maintaining a low loan balance by as much as 30% of your limit. You don’t need a flawless credit record, but you need a credit score of 720 to access the lowest interest rates.
Your debt loads relative to income have to be smaller than in the past, and you must fully document income and assets, which is very different from a couple of years ago.
You generally need to have an equity stake of at least 20% in your home. In the most challenged markets, you need much more.
Consider the pros and cons of your situation before moving forward.
Pros:
- you may be able to lock in a lower interest rate than you currently have
- you may be able to reduce your monthly payment
- it will allow you to switch to a different type of mortgage (ex: adjustable rate mortgage to a fixed rate mortgage)
- you may be able to cash out a portion of your home equity
- you may be able to extend or reduce the length of your loan
Cons:
- you will have to pay closing costs, which can be substantial
- the closing costs could counteract any savings you’d get from refinancing
- your new mortgage could end up being larger than the one it’s replacing
- you could end up paying more in interest if you extend the length of your loan
- a cash-out refinance will reduce the amount of equity that you have in your home
- if you take out a substantial amount of equity, your monthly payments could go up
It’s important to note that interest rates and points are inversely related, basically the greater the points paid at closing, the lower the interest rate: paying points and fees essentially means you are buying the interest rate down.
You should also consider the following:
- Are the savings to be generated from refinancing the loan significant? If your mortgage’s current interest rate is at least 2 percentage points higher than the prevailing market rate, then you should take advantage of a refinancing loan. For this is the acceptable safety margin, in balancing the costs of refinancing your mortgage against the savings.
- What is considered an acceptable length of time to live in your house before you can realize significant savings? Some financial experts have determined three to five years. It doesn’t make much sense to realize 2 years into your home occupancy, and you will find a harder time finding a lender who will work with you.
A mortgage refinance can provide an excellent opportunity to rework your mortgage into something that works better for you. Examine your goals, weigh the pros and cons, then find a lender that can meet your needs.
Tags: closing costs, credit score, fees, home mortgage, reduced interest rates, refinance
Leave a Reply