For homeowners who are looking to lower their monthly payments and save more money, refinancing their mortgage is one perfect solution. This process is basically about replacing the current house loan with a new one that offers different monthly payments or interest rates. Refinancing is beneficial for providing you some breathing room and achieving your financial goals.
Apart from the potential of lowering your monthly payments and getting better interest rates, refinancing also allows you to pay off your house sooner and cash out your equity. However, keep in mind that refinancing a mortgage is a complex process. And if you want to avoid the pitfalls, you need to do it wisely. Let’s explore the most important factors that you should take into account before refinancing your mortgage.
1. Goals or reasons
While mortgage refinance is an excellent way to lower your interest rates, it shouldn’t be the only reason to proceed. Some want to lower their monthly bills, while others aim to become mortgage-free a few years sooner. For instance, going from a 20-year team to a 15 can amazingly cut your total interest costs by half.
There are homeowners who also opt for a cash-out refinance to fund some house improvements and pay off high-interest debts. Regardless of your reason, financial experts remind homeowners to be careful in estimating their ability to make higher payments for shorter terms. If you’re not careful, refinancing a home loan can end up being more costly than you expect it to be.
2. Credit score
Just like in getting your original mortgage, having very good credit plays a huge role in qualifying for a refinance. In recent years, many lenders have become stricter with approving loans. So, if you want to get the best and lowest mortgage interest rates, you’ll need to have a credit score of at least 760 or up. It is also ideal if you have a debt-to-income ratio of 36% or less. Look into your existing debt, credit history, and current income when planning for a mortgage refinance.
3. Current income
Besides your credit standing, applying for a mortgage refinance will require you to provide proof of employment and income. This is also something that you should personally check out to determine if your new loan will still be suitable for your income status. Generally, your application is likely to be affected if your work status changed in the past years.
For example, if your income dropped, you will obviously find it harder to get approval for your refinance. On the other hand, you are likely to get more favorable terms and better rates on the mortgage refinance if your income is higher than before.
4. Closing costs
In a general setting, the closing costs of refinancing a mortgage can range from 2% to 6% of the amount. You can roll them up into the new loan if you have no cash to pay for upfront. But doing so means that you will have to pay interest for them, too, increasing your total loan amount. Alternatively, you can opt for a no-cost home loan in which you don’t have to pay for the closing costs and fees upfront. This is ideal if you can’t take care of the settlement costs right away.
On the other hand, you can choose to go with traditional refinancing in case you have the cash to pay for the closing costs. These costs include credit report fees, survey fees, lender origination or administration fees, title services, attorney costs, underwriting fees, and appraisal fees.
5. Home equity
The last important thing to check before applying for a mortgage refinance is the equity in your home. In some cases, you can get by with as little as 5% of home equity. However, most lenders require homeowners to have at least 20% equity in their homes. They prefer borrowers that are likely to be less of a lending risk.
If you want to qualify for lower fees or a lower interest rate, you’ll need more home equity. You can calculate the equity in your home by subtracting your current loan balance from the market value of your house. If you don’t know the value of your house, you can contact a local real estate agent for help.
Mortgage refinancing is an excellent solution for homeowners who want to obtain more manageable payments and predictable costs. By understanding the factors discussed above, you can have an easier time choosing the type of refinancing that best suits your needs and desires. In case you need further guidance with the process, be sure to contact a reputable mortgage loan officer for advice.