Buying or building a home is a strange blend of dreams and mundane work. And if that isn’t too much to deal with, there is your mortgage to worry about as well. Now you might be living in your home for a long while but it is only now that the interest rates are steadily declining that you consider refinancing your mortgage.
While many homeowners feel tempted by the incentives to refinance their mortgage, your decision should be in consideration to your unique financial circumstances. If you have already considered refinancing but are not sure if it is right for you, we are here to help.
Read this post to learn about the things you need to consider for making your mortgage refinancing work!
What Is Refinancing a Mortgage?
Refinancing a mortgage is about taking out a new loan to pay off your original mortgage loan. It allows the homeowner to get a better interest term and rate than the first one. The lender pays off the first loan, allowing you to have a second loan in its place, rather than making a new mortgage and throwing out the last one.
With perfect credit history, it can be a great way to convert a variable loan rate into fixed as well as get a loan on a lower interest rate. This means that for borrowers that have less than perfect or bad credit score, this option might be like skating on thin ice. Most homeowners decide to refinance when they have equity on their home, which is the difference between the amount owed to the mortgage company and the worth of the house.
Things to Consider Before Refinancing Your Mortgage
Here are the essential things to know before you refinance your mortgage:
Your Home Equity
Refinancing your loan can be expensive. Before opting for refinance check the ongoing mortgage rates and compare them with your current mortgage. Evaluate the equality of your property’s current equity. You will get a good idea of how much your home is worth and how much loan will be approved for you.
Depending on the market and your financial situation, you might owe more than the worth of your house or your house might not have any equity at all. Equity is one of the most important factors that increases your chance for qualifying for refinancing.
Your Credit Score
A refinance loan approval is largely dependent on your credit score, debt and income. Increasingly strict criteria for loan approval have made credit scores crucial in this process. Even good credit score can entail refusal for your refinance application. Your credit score being lower than the time you first bought your home can end you up in the high interest rate category. A credit score of 720 or higher is required by lenders for lowest interest rates as any score lower than this will not be enough to manage you a low interest rate.
Debit to Income Ratio
Your credit score increases with a stable career as you pay your bills on time and so do your chances of getting a loan. Debt-to-income ratio is determined by how much of your gross income is being spent on debt payment. Having a pre-existing mortgage loan is not only bad for your credit score but present criteria for credit score makes it even more difficult for you to get a loan on low interest. Ideally, you need to have your monthly mortgage payments at 30 percent or below and they should not go above 36 percent.
The Cost of Refinancing
Another important thing to consider is the cost of refinancing, which is usually 3-6% of the total loan amount. The good news is you can find several ways to reduce this cost or wrap it up into your new loan. Especially if you have enough equity, you can roll the cost into your loan and increase the principal. A few lenders also offer refinancing without a cost, but this usually comes with a slightly higher interest rate to cover this cost. That said, you should expect the following closing costs included in your refinancing costs:
- Application fee
- Title insurance and title search
- Lender’s attorney review charges
- Costs incurred in loan origination
The Difference Between Rates and Terms
A lot of borrowers usually go after the the best interest rates when it comes to refinancing. While there is no problem there, you should know your goals before making a decision. If you want to reduce your monthly payments, you should opt for a loan with the lowest interest rate for the longest term.
On the other hand, if you want low interest over the life of the loan, you should go for a loan with the lowest interest rate and at the shortest term.
Many homeowners rely on their mortgage interest reductions to lower their federal income tax. This means it is possible that if you refinance your mortgage and start paying less in interest, your tax deductions might also decrease. However, this factor on its own is not a good enough reason to avoid refinancing altogether.
Another thing to remember is that your interest deductions will change over the initial life of your mortgage loan. This is likely to happen when the interest percentage of your monthly payments become higher than the principal. Regardless of the terms and your situation, it is best to consult a professional tax advisor before heading into a new mortgage loan.
Whether refinancing is the right move for you or not depends on various factors that only you can determine. So the best advice would be to take your time to understand your situation and research your options thoroughly. Lastly but most importantly, run the numbers to find out if it’s the right time to set out on this path.
Streamline your budgeting calculations and make smart financial decisions with the help of the Doctor Money app. At the end of the day, refinancing your mortgage is all about accurate calculations and wise decisions.