Refinancing 101 – What You Need to Know
When mortgage interest rates are low, many homeowners consider refinancing as a way to lower their monthly payments and adjust the terms of their mortgage loans.
It’s important to remember, however, that refinancing a mortgage should be based on the homeowners’ individual finances and long-term goals, not just this week’s mortgage rates!
Let’s review what you need to know before refinancing your mortgage.
Do You Have Enough Equity to Refinance?
The more equity you have in your home, the easier it will be to refinance your mortgage loan. That said, it’s important to calculate the equity in your home before contacting your chosen mortgage provider.
To calculate the amount of equity you have in your home, simply subtract the amount you owe on your current mortgage loan from your home’s appraised value. According to Investopedia, homeowners with at least 20% equity are more likely to be approved for a new home loan.
Understand Your Credit Score & Debt-to-Income Ratio
To qualify for a new home loan with an ideal interest rate, a high credit score and low debt-to-income ratio is essential. Moreover, a credit score of at least 760 and a debt-to-income ratio of 36% or less is ideal, according to experts at Investopedia.
In addition to a high credit score and low debt-to-income ratio, borrowers should strive to maintain a long and stable job history, substantial savings, and above average income. This is because most lenders strive to keep a borrower’s monthly payment under 28% of the borrower’s gross monthly income.
The Cost of Refinancing
While some lenders offer a “no-cost” refinance, the typical cost to refinance a mortgage loan costs between 3%-6% of the total loan amount. That said, there are several ways to reduce the cost of refinancing, including incorporating the costs into the new loan (thereby increasing the principal). In some cases, the lender may even cover a portion of the cost to refinance.
Make sure to speak with your individual lender to determine the most cost-effective way to refinance your specific mortgage loan.
What is your ultimate goal?
When considering the option to refinance your mortgage loan, it’s important to establish the financial motive behind the decision.
For example, if you would like to significantly reduce your monthly payments, then a loan with the lowest interest rate for the longest term would be ideal. However, if your goal is to pay less interest over the lifespan of your mortgage loan, then you’ll want to choose a loan with the lowest interest rate at the shortest term possible. Furthermore, if the ultimate goal is to simply pay off your mortgage loan as fast as possible, then a mortgage loan with the shortest term would be best.
As always, discuss your specific financial goals with your lender to determine which type of home loan will help you to achieve your long-term financial goals.
Know Your Break Even Point
A key factor in determining whether or not to refinance your mortgage loan is the break-even point.
This is the point at which the cost of refinancing has been met by your monthly savings and any savings thereafter are the homeowners’ to keep. As an example, if the cost to refinance is $5000 and you’re saving $250 per month over your previous mortgage loan, it will take 20 months to recoup your costs.
Therefore, if you intend to sell your home within two years, refinancing your mortgage may not make sense under this specific scenario.
Private Mortgage Insurance & Tax Implications
It’s important to remember that homeowners with less than 20% equity in their home at the time of refinancing will still be required to pay private mortgage insurance. In addition, if you choose to refinance and pay less interest on your mortgage loan, then your mortgage interest deduction may be much lower than in years past.
Utlimately, refinancing your mortgage loan is a complicated process and requires due diligence on the part of the homeowner, as well as a trusted mortgage provider.
At GoPrime Mortgage, Inc., our local lenders are ready to help you determine if refinancing is the best option to achieve your long-term financial goals.