Time And Money: Deciding Whether To Refinance
Every month, you cringe at how big a chunk your mortgage payment takes out of your budget. A friend just bought a home and mentioned the mortgage rate he secured—and it’s much lower than the one you got five years ago. Or maybe you’re just tempted by all the talk radio commercials you hear claiming “rates have never been lower!” Now the idea of refinancing your home is on your mind. But how do you know whether it’s a smart decision to refinance right now and which is the best mortgage refinancing strategy for you? Deciding Whether To Refinance can be a tough decision.
Refinancing Is Similar To Securing Your First Mortgage
In some respects, refinancing your home is akin to securing your first mortgage. It makes sense to shop around and compare the rates offered by several lending institutions, including traditional banks, your credit union (if you belong to one), mortgage banks, mortgage brokers and online resources. But instead of just comparing these deals to one another, you also need to compare them to your current mortgage and calculate whether the fees associated with refinancing will be offset by actual savings over the life of your loan.
The expenses associated with refinancing your home mirror those you took on when you obtained your first mortgage. Typically these costs—which include a new appraisal plus loan origination, title, and closing fees—add up to between 2% and 4% of the total amount you’re borrowing. Do the math and determine whether you are realistically estimating the savings you expect from refinancing. Figure out what your break-even point is: how many years do you have to pay your new mortgage to recoup all the upfront expenses? If it will take you ten years and you’re planning to retire someplace warmer in five, refinancing may not make sense for you. On the other hand, if you plan on staying in your home forever (or at least until you’ve paid off your mortgage), refinancing now could be a very smart decision.
Review Your Current Mortgage
Few of us remember all the details of complex financial documents once we’ve signed them. Before you refinance, it’s important to review your current mortgage and make sure you won’t be liable for pre-payment penalties when you move your mortgage from one lender to another. If you are required to pay pre-payment penalties, a factor that cost into your estimation of how much money you will save by refinancing.
Before you even begin to approach lenders for a new mortgage, be sure to take a look at your credit score. Paying down high-interest credit cards can improve your debt-to-income ratio, which is one important factor lenders will consider before offering you a new mortgage. Many lenders will not consider you for a mortgage if your debt-to-income ratio is higher than 43%. Bear in mind that the rates advertised by lending institutions are usually their lowest rates, not their average rates. These rates are reserved for customers with very high credit scores, so it makes sense to do what you can to improve yours.
What Are Your Financial Goals
Finally, do some financial soul-searching. What are your goals in undertaking a refinance? While securing a lower interest rate is one of the most popular reasons, it’s not the only one. You might want to refinance your home in order to pull some equity out and attend to some necessary home repairs or pay down high-interest credit cards. You may want to lengthen the term of your loan to bring down your monthly payment and help you out of a cash flow crunch. You might even want to switch from a 30-year to a 15-year mortgage since shorter-term loans typically come with lower interest rates.
Just as your current mortgage lender requires you to carry homeowner’s insurance, so will your new lender. If you’re looking to lower your expenses overall, refinancing is an excellent reason to review your homeowner’s insurance policy. Talk to your insurance broker to learn whether you can reap additional savings from updating your policy.