You can’t drive by a bank or watch television without seeing advertisements for mortgage loans. With interest rates under 4%, and predicted to stay low for the next couple of years, now is one of the best times to apply for a mortgage loan. A low rate increases purchasing power if you’re looking to buy, and if you’re thinking about a refinance, a low rate can drop your current mortgage payment.
A refinance can definitely free up money and lower your monthly expenses. But while your present lender and other banks may contact you with attractive rates, there’s plenty to consider before you refinance.
This isn’t a decision to take lightly. Here are five questions to ask yourself before refinancing your house.
1. How’s my credit score?
The fact that you own a house and currently pay a mortgage doesn’t guarantee an approval. A refinance is a brand new loan, and like your original loan, your mortgage lender will review your credit and income. Any changes in your credit history or finances can affect the loan application. This is news to many homeowners. Some people attempt refinancing after losing a job to lower their mortgage, but this doesn’t always work.
Before you meet with a lender and complete an application, check your credit report and credit score. Any negative item on your report can stop a refinancing, as well as a low credit score. Conventional mortgage loans require a score 680 or higher, whereas an FHA mortgage requires a score 620 or higher. Take steps to build your credit (pay down debt and pay your bills on time) and keep accurate income records.
2. Why do I want to refinance?
What do you hope to accomplish by refinancing? Having a clear goal in mind can help you take the best approach. A refinance can achieve multiple financial goals. Some people refinance to get a better interest rate and lower their monthly payment. Meanwhile, other property owners refinance to tap into their home’s equity and acquire cash for home improvements, debt consolidation and other things. Then again, maybe you want to convert your adjustable rate mortgage to a fixed rate. Make sure your goal is clear before you speak with a mortgage lender.
3. Do I plan on moving in the near future?
The decision to refinance doesn’t mean that you’re stuck in your house forever. But if your intentions are to move within the next two to three years, a refinance doesn’t make financial sense. Here’s why.
Like your original loan, there are costs associated with refinancing a house. Closing costs vary by state, but can run as high as 5% of the mortgage loan. There are different ways to deal with closing costs. You can pay these costs out-of-pocket, but depending on the lender, there’s the option of wrapping these costs into the mortgage. Whatever approach you decide, it can take a few years to recoup your closing costs.
Let’s say you refinance your mortgage and save $150 a month. That’s a big deal, especially if you need to lower expenses. But what if you paid $4,000 in closing costs? Given this scenario, it’ll take 26 months or a little more than two years to break even. If you move before you break even, you actually lose money.
4. Do I have enough equity?
Equity is a factor that many don’t consider when refinancing. The thought of lowering your home loan payment and saving money each month is thrilling. That’s until you learn that a particular lender will not refinance your mortgage because you have less than 20% equity. But there is good news for homeowners with no equity or little equity. Programs offered by Fannie Mae and Freddie Mac can assist in these situations, and if refinancing to an FHA mortgage, you only need 5% equity.
Getting a home appraisal is the best way to gauge your home’s worth. An appraiser walks through your house, and based on comparable sales in your area, determines your property’s worth. This information can help you decide whether now’s the best time to refinance. Additionally, knowing your home’s value provides clues as to the best programs and mortgages to look into.
5. What are my options?
There is no “one-size fits all” refinance. Different options are available, but don’t rely on your mortgage lender to pick the best mortgage. Options can include a conventional mortgage, an FHA mortgage, a fixed rate and an adjustable rate mortgage. Likewise, you can go with a traditional 30-year term, or shorten your mortgage length with a 15-year or 20-year mortgage.
Consider your long-term financial goals when choosing a mortgage. Do you want to eliminate the debt quickly, or are you more concerned with keeping your payments low? Do you want predictable payments? There are advantages and disadvantages to every option, and the type of mortgage chosen has a bearing on your monthly payment. Do your research and ask plenty of questions? Your mortgage lender can provide sample monthly payments with different options, make suggestions and provide worst case scenarios. Ultimately, it’s your decision and you need to select the option that’s the most affordable.