If you are thinking about refinancing your home, you’re in good company. When done at the right time – namely when interest rates drop one percent or more lower than your current mortgage interest rate – refinancing has the potential to lower your monthly payments and increase your monthly cash flow.
Before jumping into the process, remember that mortgage rates alone should not determine your decision to refinance. The Home Loan Arranger specializes in residential lending in Denver, Colorado, and we have compiled 10 things you should know about refinancing your home.
1. Determine Your “Why” For Refinancing
Refinancing a house is meant to help you lower the amount you will be paying in interest, thus drastically reducing the total number of years you are in debt with a mortgage. Most homeowners who refinance have the simple goal of lowering monthly bills. Another goal might be to shorten the overall term of your loan by switching to a 15-year loan instead of whatever you currently have. Shortening the term could end up cutting total interest costs by half. When considering shortening the term of your loan, be sure to realistically assess whether the higher monthly payment will be something your budget and spending habits can handle.
2. Consider the closing costs and when you will break even
Be aware that you will indeed pay for refinancing. Homeowners must pay closing costs – the one-time fees that are due when you take out a loan. People should expect closing costs to be approximately 2 to 4% of the total loan value to cover things like appraisal, underwriting, and title. Do the math to determine if and when you will end up saving money. Divide your closing costs by the amount you will be saving per monthly payment to determine the number of months it will take you to break even.
For instance, if your closing costs are $3,000 and you can save $200 a month with refinancing, you will break even in 15 months. However, if your monthly savings are more like $50, then it will take five years to equalize. If you plan to sell your house before your estimated date to break even, refinancing is not a good strategy for now. Another rule of thumb in residential lending is to try to recover your costs within two to three years.
3. Realize that a truly “no cost” refinancing option does not exist
What about the no-cost refinancing options offered by some lenders? That option, rather than having borrowers pay one-time fees, merely adds the cost into the interest rate. Sometimes this can bump the interest rate up as much as half a percentage point higher. So, while you’ll pay nothing out-of-pocket when you refinance, you will end up paying through a higher interest rate.
4. Refinancing to obtain cash is a viable option
If your plans or goals necessitate getting an additional lump sum of cash in the immediate future, refinancing to obtain cash is indeed an option. Cash out refinancing is a way to get cash immediately for major purchases such as home improvements, weddings, or travel. Borrowers who go this route should compare the benefits of refinancing to other methods, such as home equity loans.
5. Know your credit score
Just like your credit score plays a big role in your ability to qualify for a mortgage, it will play a big role in the process of refinancing. Your credit score will influence the interest rate you can receive. Generally, borrowers with higher credit scores receive lower interest rates.
The exact credit score you’ll need to qualify depends on the type of loan and your specific lender’s requirements. For a conventional loan, the minimum credit score may need to be at a minimum of 620 to 720 depending on the loan’s LTV (loan-to-value ratio), your debt-to-income ratio, and the amount you have in cash reserves. The loan-to-value ratio is the amount of financing you need versus the value of the house.
6. Calculate your debt-to income ratio
In addition to having a solid credit score, your lender for refinancing may require you to meet a certain debt-to-income ratio. Typically, lenders want borrowers to have monthly housing payments below a maximum of 28% of their gross monthly income. The overall debt-to-income should be 36% or less. If you find that you’re not meeting these benchmarks, consider taking steps to pay off some debt before refinancing.
7. Assess your home’s equity
Home equity represents the value of property after all of its liabilities have been paid. For example, a home worth $300,000 with a $200,000 mortgage would have $100,000 in equity. The equity of your home will be the first qualification you will need in order to refinance. Homeowners with 20% equity – or higher – will have a less difficult time qualifying for a new home loan. If that’s not you, don’t write off refinancing yet: visit a lender to discuss your situation and needs to help you reach your goal.
8. Remember to account for private mortgage insurance
If your home has less than 20% equity when you refinance, paying private mortgage insurance (PMI) will be required. For homeowners who already pay PMI this will not be anything new, but sometimes this addition shocks homeowners who go through the process of refinancing only to find out that their home has decreased in value since the purchase date. In those cases, the homeowners will have to begin paying PMI, which could eliminate any reduction in monthly payments after all. Professionals at residential lending companies like The Home Loan Arranger can calculate whether you will need to pay PMI or not.
9. Think About Taxes
If you are someone who counts on your home loan interest deduction to lower your federal income tax bill, know that after refinancing your property there is a chance your next tax deduction could be lowered.
Or maybe taxes are one of the reasons you’re considering refinancing in the first place. Your interest deduction will change over the early life of your new loan when the interest percentage of your monthly payment becomes higher than your principle.
Whatever your intent, refinance companies like ours are here to help provide you with reliable information in Denver CO.
10. You have the freedom to change your mind
If your risk-tolerance is low, you’re experiencing decision fatigue in tumultuous times, or something completely unexpected comes up after you begin the refinancing process, know this: you still have time to change your mind. By law, when it comes to primary residences borrowers have three business days after signing the loan contract to cancel the loan for any reason. That’s also the reason borrowers do not receive money until three days after the contract was signed.
Through all of the nuances and technicalities of the home refinancing process, the reputable lenders at The Home Loan Arranger will be there for you. Contact us today and we will answer questions and speak to any of your concerns. If refinancing turns out to be a positive decision for you, we can help you to get started and carry the process of refinancing through to fruition.