Refinancing Your Mortgage: Is it right for you?

A lower interest rate for anyone carrying a mortgage is awfully tempting. Who doesn’t want to pay less each month? Plus it seems everyone is doing it. But refinancing your mortgage really depends more on you, that what today’s interest rates are showing.

Here are some key things to consider when thinking about refinancing

1. Your Credit Score
Lenders are looking for a score of at least 720 for you to qualify for the lowest interest rate. A lower score may not necessarily exclude you, but interest rates and fees may be higher, making a refinance not that great of a savings measure. 

2. Equity

If you haven’t built up equity in your home, then refinancing may not be an option for you. Lenders of conventional loans are typically looking for 10%-15% equity. 

3. Your Goal

Before shopping for a new loan, be clear on what your refinancing goal is. If your goal is to reduce your monthly payments, seek out a loan with the lowest interest rate for the longest term. If you want to pay less interest over the length of the loan, look for the lowest interest rate at the shortest term. If you want to pay off their loan as fast as possible, look for a mortgage with the shortest term at payments you can afford.

4. Costs

Surprise, there are costs associated with refinancing a mortgage - usually 3% to 5% of the loan amount. If you have enough equity, you can roll these costs into your new loan. Keep in mind this will increase your principle. Also keep in mind that a “no cost” refinance usually involves a higher interest rate to cover closing costs. 

5. Debt to Income Ratio

Consider paying off or paying down your debt before seeking to refinance your mortgage. Lenders are generally looking for a debt-to-income ration of no more than 36%. However, with positive factors, such as high income, stable job history, or sizable savings, some lenders may up the ratio to 40%. 

6. Points

Points, usually equal to 1% of your loan amount are paid to bring down the interest rate. When comparing loan offers, be sure to look at how many points you will have to pay as these will be due at closing or wrapped into your loan. 

7. How Long do You Plan on Staying in Your Home

This is a question often overlooked when considering refinancing a mortgage. It’s important to figure out the breakeven point of your new loan - that is, when your monthly savings cover the cost of the refinance. For example, if your refinance costs are $3,000 and your new loan saves you $150 per month, you will need 20 months to recoup the cost of the refinance. If you intend to sell your home in less than 2 years, then refinancing doesn’t make sense for you. 

8 Private Mortgage Insurance

If you have less than 20% equity in your home, you’ll have to pay private mortgage insurance (PMI). If you’re already paying it, then it’s probably no big deal. But if PMI is new to you, then your new lower payments may not be enough to offset this additional expense. 

9. Taxes

Consider that if you refinance and are paying less interest, your federal income tax deduction could be lower. 

The Bottom Line

Refinancing may be a great thing for you. Or not. Like any financial transaction, it’s important to do your due diligence. Shop around. Seek out sound advice from a tax advisor and reputable mortgage professional. 

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