There are a couple of different reasons why someone may choose to refinance a mortgage, though low-interest rates tend to be one of the biggest driving factors. While lower interest rates can be a great advantage, they shouldn’t be the primary reason for refinancing your mortgage.
There’s a lot that happens during a refinance and if a low-interest rate is your only reason for doing so, you may find that the refinance isn’t worth it. If you’re deciding to refinance your mortgage for other reasons as well, though, then it may still be worthwhile to follow through with it.
Whatever your reason for refinancing, here are some things you should know beforehand to help you determine if a refinance is right for you.
#1. There will be new lending costs
Unfortunately, a refinance is just another way to say “taking out a new loan”. You’ll have to pay new lending fees that may or may not be rolled into your new monthly payments. Depending on your new lender’s policies, your old lender’s closing requirements, and the amounts of both your new loan and your old loan, the cost to refinance will vary greatly.
#2. You should understand why you’re refinancing
Again, deciding to refinance your mortgage just so that you can get a lower interest rate may not be worth it in the long run. With the extra costs you’ll pay to both start a new loan and close out your old one, you’ll need to know why refinancing is worth it to you.
Here are a few of the common reasons why someone might decide to refinance (excluding lower interest rates):
Change Your Mortgage Term
Say you took out a 30-year mortgage, but now you want to change the term length for whatever reason. Maybe you want a shorter term, maybe you want a longer term. Whatever the case, refinancing your mortgage is a good way to do so.
A cash-out refinance is a good way to help you consolidate debt. If you have a lot of high-interest credit card debt or you’re making several payments on multiple loans, consolidating your debt into one monthly payment is a good way to make your life easier.
With a cash-out refinance, you can take out a new loan and use whatever amount of home equity you have as cash.
Here’s a quick example:
Your house is worth $250,000 and you’d already paid off $75,000. You have $10,000 in credit card debt and you just bought a $25,000 car that you’re paying off. Instead of taking a new loan out for the remaining $175,000 that you owe on your home, you can accept a loan from the new lender for $210,000 and use the extra $35,000 as cash to pay off both your credit card and your car. Now, all your debt is consolidated and you can pay it off over time.
#3. Your breakeven point may be further than you think
When you refinance, you reset the clock on your mortgage, but you also set a new breakeven point. With both the new loan application fees and the old loan closing costs, you’ll be in the red until a certain point. To guarantee that your refinance was worth it, you should know when this point is.
Using a refinance calculator can give you a decent idea of when you’ll break even on your refinance. What’s important to understand is that it may take several years before your break even on your refinances, so if you don’t plan on staying in your new home for that long, it may not be worth the investment.
#4. Be aware of PMI requirements
If you’ve had to pay private mortgage insurance of some kind in the past, then you know that they’re an annoying monthly cost that just feels like losing money unnecessarily. While you’re required to pay it, this part of your monthly payment doesn’t go towards paying off your mortgage.
Most people can get rid of PMI requirements when they refinance, but it’s important to know what those requirements are so that you don’t accidentally overlook them and get trapped paying PMI again.
When you refinance, you’ll need to have at least 20% equity to get out of paying PMI. If you don’t have at least 20% equity, you’ll end up paying PMI until you do. As the value of your home will likely fluctuate with the market, your equity will as well. To avoid an unhappy surprise, be sure to get your home appraised before moving forward with a refinance.
#5. There will be more financial and credit requirements
Just like when you first got your mortgage, you’ll need to meet specific financial and credit score requirements to qualify for a refinance. This will depend on the lender again, but try to keep a low DTI ratio and a good credit score to improve your odds.
Some refinances will have lower credit score requirements whereas others will expect a score of 600 or higher before you qualify. As for your DTI, make sure that it’s been relatively even over the last two years as most lenders will look at your debt and your income within that period.
Decide Based on Your Needs
Every homeowner will have different needs, so there’s no one answer to whether a refinance is a good idea or not. Similar to when you took out your first mortgage, though, you must take the time to shop around and investigate all of your options before you commit to a refinance.
Owning a home is a fantastic privilege, but it comes with a lot of extra things to think about and mortgage payments can be expensive. If and when possible, lowering your monthly payments is a good way to make homeownership more affordable, but only when it fits within your needs.