Refinancing your mortgage is not a decision to be made just because the markets look good and the interest rates are low. It’s a major decision that includes a number of important moving parts.
While there are many benefits to refinancing your mortgage, it doesn’t come without risk, either. Ultimately, it’s about making the smartest financial decision based on what it will really cost you.
Here’s what to know about refinancing your mortgage and the reality behind the decision-making process.
Most of the time, homeowners are looking to lower their monthly mortgage payment, pay off their mortgage faster, or want to pay off a mortgage at a lower interest rate. All of these reasons are smart reasons for refinancing a mortgage.
Some not-so-smart reasons for refinancing include cashing out equity on your home to go on a spending spree or vacation. Or cashing out equity for major home renovations — though this decision can sometimes be beneficial.
So, what is the process of refinancing a mortgage? In short, it involves paying off a current mortgage so that you can take out a new one. However, the costs associated with doing so are sometimes not worth it. Just some of the fees that go with refinancing include:
What many homeowners fail to realize is that staying in your current mortgage may be a better option if refinancing costs outweigh what you’re going to save. But in saying this, there are many benefits to mortgage refinancing, too.
You get to save money by reducing your monthly mortgage repayment. You may get a shorter-term loan and can pay off your mortgage faster. The costs of your mortgage may be more predictable and could even consolidate some of your debt. However, all of these benefits are contingent on when you decide to refinance a mortgage.
Making this decision is not always easy, and definitely should not be rushed. Ideally, you need a few important factors to line up in order to make the best-timed decision about refinancing. Experts recommend that the best time to refinance is when:
Do your homework on what the total costs would be when choosing to refinance. You need to consider what your new mortgage payment will be, the mortgage term, and how it suits your budget today, and in the future.
When it comes down to making your final decision, these factors must be considered first:
As mentioned, refinancing a mortgage is not exactly a walk-in-the-park, and it can be expensive exercise too. This is why it’s so important that you sit down and figure out your exact reason for refinancing.
Each homeowner has their reasons, but you must ensure that this reason is solid enough to outweigh the paperwork and potential cost. Whether you want a lower monthly payment, lower interest rate, or cash-out equity to do home renovations, make sure your reasoning is smart and justifiable.
The reality is this: if current mortgage rates are not any lower than what you’re currently paying, then why refinance a mortgage? It’s that simple. So before you dive into the process of refinancing, do your research on whether mortgage rates are in your favor.
Remember that mortgage rates fluctuate. Just because they are lower one week, doesn’t mean they’ll stay that way the following week. Is your ultimate goal is to pay less interest or less on your monthly repayment? Begin your refinancing application as soon as you notice that mortgage rates are in your favor.
The first major step in mortgage refinancing is the valuation of your home. From there, you’ll have a clear idea of how much equity is in your home.
You may also want to consider what the homeowners market looks like and whether other homes in your region have increased or decreased in equity, i.e. regained any of their value. It’s not always wise to refinance a home that has little or no equity. And it may not be possible with most conventional lenders, either.
Before you make your decision about refinancing you’ll also need to take a look at your current earnings and the debts you have to pay, monthly.
Your current income matters because you don’t want your mortgage payment to take up more than 30% of what you earn. Ideally, your debt-to-income ratio should be no more than 35%.
Whether you’re approved for refinancing or not, it’s always best to keep your debts low and at a manageable level, when compared with what you earn.
Why does your credit score matter when it comes to refinancing a mortgage? Because this is how most lenders make their decision based on whether to approve a new mortgage or not.
Many lenders have also tightened their belts and the loan approval process has become far more stringent over the years. Even if you have a stellar credit rating, you may not qualify for the lower interest rate mortgages, based on the lender you choose.
You want your credit score to hover around 760 or more in order to qualify for the really good interest rates that make refinancing your mortgage worth it.
The truth is, the cost of refinancing your mortgage ranges from 2-5% of your total loan amount. However, it depends on the lender you choose and whether they can include some of these costs in the total loan amount.
Generally, the greater equity your home has, the more likely these additional costs are rolled into your new loan. Otherwise, there are no-cost refinancing options. But this means you end up paying a higher interest rate in order to cover the closing costs.
This is why it’s important to do your homework on different lenders and the refinancing fees included in the process. Remember that you are fully entitled to negotiate on these fees and even ask for reductions.
You’ll also need to consider what’s more important to you when refinancing: the interest rate on your loan or the term, i.e. its length? Bear in mind that most lenders tend to focus on the interest rate of a new mortgage. But if this is not your ultimate goal, don’t just settle.
If your end-goal is to pay less on your mortgage each month, you want to go for a loan with the lowest interest rate, over the longest term. If you want to reduce the amount of interest you’re paying, go for a loan with the lowest interest rate, over the shortest term.
If you want to pay off your mortgage in the shortest time possible, opt for a loan with the shortest term, but monthly payments you can actually afford!
This is yet another reason why the equity in your home is so important when refinancing. If your home has less than 20% equity, you are often required to pay private mortgage insurance, also known as PMI.
The same goes for a reduction in the value of your home. It’s inevitable that you will have to pay PMI, too. In some cases, the additional cost of PMI does not make refinancing a smart or viable financial option.
If you are currently paying PMI on your mortgage, this will not apply to you.
Finally, there are also closing costs to consider when refinancing a mortgage. Most of the time, these costs range from 2-6% of the total loan amount. If you cannot afford these closing costs, there is a simple solution.
Generally, it can be rolled into the new loan amount which can you then pay off, over time. However, your new loan must be 80% or less of the value of your home. Remember that the addition of closing costs to your loan means you’ll also be paying additional interest.
When it comes to refinancing your mortgage, we hope this blog has helped you understand what goes into making this decision. Now that you are equipped with all the important information you need, you can make the smartest decision based on your financial reality.
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